Tag Archives: federal-reserve

Beguiled

Posted on by 
It turns out, inflation of late
Did not start to accelerate
Instead, it was mild
With doves now beguiled
But not yet declaring checkmate

The odds of a hike keep on sliding
But ere the Committee’s deciding
In two weeks, we’ll hear
Chair Warsh try to steer
The narrative with gentle (?) chiding

The fears over rising inflation have been allayed for the moment after yesterday’s CPI data was released right on expectations with monthly increases of 0.1% headline and 0.2% core and Y/Y results of 3.4% and 2.5% respectively.  For all those who have been pining for that rate hike ASAP, this was unwelcome news.  The below table from cmegroup.com shows how things have changed over the past month.

On July 13, markets were pricing a 75% probability of a hike in September with thoughts of a 50bp hike a reality.  This morning, the probability of that September rate hike has fallen to just 36%.  You may recall that I have been consistent in my views that there would be no rate hikes this year, and that continues to be my view.  If we look at the entire Fed funds futures curve, as per the next table, we now have one hike priced for December only, compared with two plus hikes several months ago.

This is not to say I believe that inflation is dead, just that it is not accelerating away.  As my friend The Inflation Guy points out in his piece on yesterday’s CPI, the data was boring, “Boring, right on expectations. The bad news is that it is boring and right on expectations…at 3%.”  This is still a far cry from the Fed’s self-defined 2% target, but fears of “Amerizuela” type outcomes are vastly overblown.  (However, you still want to protect you purchasing power and one effective way to do that is via USDi, the only inflation tracking cryptocurrency.)

Now, we still have a bunch more data before the next FOMC meeting, including today’s PPI, PCE at the end of the month and another NFP and CPI reading in September.  As well, we cannot forget that Chairman Warsh will have the opportunity to clarify his thinking at the Jackson Hole soiree on Friday morning, August 28th.

So, has anything really changed that much after the CPI report?  While the reality hasn’t shifted, it does appear that market participants are beginning to adjust their views a bit.  One number does not a trend make, nor will it have bolstered Warsh’s credibility, assuming that is in question, either.  This is a saga that will continue to play out over time.  It seems to me that if the Fed really wanted to fight inflation effectively, they would be digging much deeper into why they continue to hold >$1.9 trillion in MBS on their balance sheet and run an ample reserves framework.  Going back to scarce reserves allows the market to drive interest rates, something clearly on Chairman Warsh’s wish list.  But that will have to wait for the task force reports.

Ok, let’s see how markets other than Fed funds have responded to this news and data.  Since we are on the rates subject, let’s start there this morning with bonds which have seen yields slip -2bps in Treasuries and between -1bp and -3bps in Europe.  Oil prices (-2.1%) are slipping this morning so that appears to be the proximate cause of the yield move, a bit less concern over inflation.  Yesterday, after the CPI data, we also saw Treasury yields drop -2bps, so for now, fears of an imminent test of 5.0% on 10-year Treasuries seem overblown.  JGB yields, though, continue to creep higher, another 2bps overnight and are now just 3bps below their multi-decade high of 2.90% as per the chart below.

Source: tradingeconomics.com

Speaking of Japanese rates, Bloomberg has an article this morning explaining that the Takaichi administration is ok with the BOJ raising rates sooner, a change in the market’s perspective if not an outright change of view there.  Alas for those looking for a stronger yen and the end of the carry trade, the impact of the report was essentially nil as you can see in the chart below.  The three large, red candles just to the right of center represent the immediate aftermath of the release of the report.  Net, USDJPY is virtually unchanged on the day and the trend since the intervention remains for the dollar to move higher.  My sense is perceptions of Fed rate activity is going to have a bigger impact than the BOJ for now.

Source: tradingeconomics.com

As to the rest of the FX market, +/- 0.2% covers the gamut for both G10 and EMG blocs.  It wasn’t just the CPI report that was boring, so are FX markets overall.

Turning to equities, yesterday’s US market response was benign with only the NASDAQ showing much life, gaining 0.5%.  In Asia, though we did see Tokyo (+1.1%) rise despite talk of the BOJ being more aggressive.  Of course, the real price action remains in Korea (+3.6%), which is redefining what equity index volatility actually means.  Otherwise, there were some gainers (Taiwan, New Zealand, India) and more laggards (China, HK, Australia, Malaysia, Indonesia) but none of these moves topped 1% in either direction.  

European bourses, however, are feeling a bit better this morning led by Spain (+0.7%) and Germany (+0.5%) as earnings seem to be the driver here helping Spanish shares despite the tick higher in inflation there.  UK shares (-0.2%) are lagging after GDP and production data was on the disappointing side while the Trade Deficit expanded further.  And at this hour (7:30) US futures are little changed to slightly higher.

Finally, turning to commodities, oil’s decline seems to be attributable to the IEA reducing its global oil demand outlook (although they have been wrong about this for several years as they try to push a peak oil, transition to wind/solar narrative that is just not happening) as well as the fact that yesterday’s EIA data showed a 17+mm barrel build, a far cry from the slight draw expected and another blow to the tank bottoms story.  As to the precious metals, the luster is gone (Au -0.5%, Ag -0.6%, Cu -0.5%) although copper remains quite close to its all-time highs, and both gold and silver remain in short-term uptrends after seemingly having bottomed back in July.

On the data front, this morning brings the weekly Initial (exp 202K) and Continuing (1800K) Claims data along with PPI (0.2%, 4.9% Y/Y) and core PPI (0.3%, 4.2% Y/Y).  It strikes me that neither of these releases are going to be major market movers.

It is summer, and I assure you trading desk vacation schedules are far more important than secondary economic data releases.  I suspect another boring day overall here.  In fact, I suspect that until Warsh speaks in two weeks, we may see very little activity across most markets.

Good luck

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Smart or Insane

Posted on by 
While pundits all like to complain
About everything, smart or insane
When stock markets rise
It’s no real surprise
That few people care what they’re sayin’

As penance for yesterday’s overly long diatribe, I will keep this morning’s much shorter, especially since there is not nearly so much interesting to discuss.  There are still many discussions on the whys and wherefores of the US joining with Japan in intervening in the FX markets, with a pretty even mix of those saying it won’t matter and those saying it is a game changer.  As you can see from the chart below, this morning the beleaguered JPY (-0.45%) is slipping a little, but hardly enough to matter in the context of last week’s gains.

Source: tradingeconomics.com

Of course, we won’t really know how effective this bout of intervention has been for at least a few weeks/months, as the history, clearly shown on the chart is a big move higher followed by a gradual depreciation in the yen.  Will that play out again?  My suspicion is that absent a policy change by the BOJ (i.e. a more aggressive rate hike schedule) or the Japanese government (i.e. less fiscal stimulus) the answer is no.  This is especially true if the Fed raises rates, although I still do not believe that is coming soon.  

However, it is important to remember that the Fed funds futures market is confident of a hike by October, with a two-thirds probability of one next month as per the below cmegroup.com table.

Turning to the other major discussion from yesterday, the ongoing feedback/blowback from the Fed’s no movement, and more importantly from Warsh’s behavior during the press conference, that too remains a topic of discussion with pundits on both sides adamant that he was either right or wrong on both measures.  The only thing I am sure about is that he doesn’t care much about what the pundits are saying.  Rather, he is very likely focusing on getting his points across to the rest of the committee, and that will be a tough job.

In 2025, FOMC members gave, on average, one speech a day which added to the forward guidance which was a key tool in their toolbox.  You know I often railed against the ongoing verbal diarrhea from these folks as from the best I could tell, nothing said was ever designed to sway opinion, merely to burnish each speaker’s credentials.  And they clearly loved the quasi fame that came with it.  In fact, I suspect it is that very quasi fame the committee is most reluctant to cede.  Chairman Warsh has his work cut out for him.

As to today’s new stories, there are none, at least none of note.  There are more conflicting comments from President Trump and the Iranians about negotiations or not.  Yesterday’s ISM data was quite positive, coming in at 55.6 vs 54.0 expected, just another indication that the US economy continues to tick along quite nicely.  After that, the news heads towards the political with several key primary elections to be held today with DSA candidates picked to win and run in the general elections in November.

But what has everybody happy is the fact that equity markets are showing strength once again.  I read that of the S&P companies that have already reported, 85% have beaten estimates, a much higher than normal percentage (76% is the norm), and another positive for market bulls.  

So, let’s take a look at how markets behaved overnight with that theme.  The strong US performance was followed by a more mixed session in Asia, although there were more gainers (Tokyo, China, Korea, Australia, Indonesia, New Zealand) than laggards (HK, India, Philippines).  The tech story remains the major story since the oil story has become so confusing on a daily basis, I feel like most investors have moved on.  Meanwhile, in Europe, it is a broadly positive session as well led by Germany (+0.6%) and the UK (+0.35%) while France (+0.1%) and Spain (0.0%) are not quite as happy.  Arguably, the biggest news in Europe continues to be the unprecedented flood of illegal immigrants into Ceuta, Spain and the punditocracy is actively expressing their opinions on the issue, although whether there is a direct impact on the equity market in Madrid is unclear.  Lastly, US futures at this hour (7:20), are all pointing higher again as the market awaits earnings from SpaceX this afternoon after the close.

In the bond market, there continues to be a great deal of garment rending and teeth gnashing amongst the financial illuminati as yields hold the bulk of their recent gains.  This morning Treasury yields have backed up 1bp after yesterday’s -5bp decline, although European sovereign yields are generally lower by -1bp this morning.  As of now, there is no answer to the question of is the bond market focused on inflation or excess issuance although it could well be a little of both.

Remember when oil (-0.8%) was the only market that mattered, and all other trading looked there first.  We heard stories about $200/bbl coming soon and tank bottoms as reserves emptied and a growing concern about future economic activity.  Well, that never really happened.  As I type, WTI is back below $80/bbl and I particularly like this chart that calculates the mean price over the past 6 months ($86/bbl) and shows no trend whatsoever.  

Source: tradingeconomics.com

To me, this implies there is a new equilibrium although I suspect that when the hostilities cease, and I believe they will at some point this year, we will see sharply lower prices for crude and products.  As to metals markets, they remain relatively uninteresting with modest gains today (Au +0.2%, Ag +2.4%, Cu +1.7%).

Finally, in the FX markets, away from the yen the dollar is under a bit of pressure this morning.  First, for all of you who follow the DXY and were excited by the ostensible breakout above 100.50, as you can see in the below chart, that story appears to have ended for now.

Source: tradingeconomics.com

But away from the yen this morning, the rest of the G10 have all shown modest gains led by AUD (+0.5%) after some positive household spending data.  Otherwise, 0.1% to 0.2% is the state of the day.  In the EMG bloc, ZAR (+0.4%) is the leader of the pack on the combination of softer oil prices and stronger metals prices.  Too, BRL (+0.25%) and MXN (+0.25%) seem to be benefitting on the same basis.  Otherwise, it’s hard to get excited here.  Perhaps another bout of intervention will perk things up, but I doubt that will happen soon.

On the data front, there’s quite a bit to be released this week culminating in the Friday NFP report.

TodayTrade Balance-$73.0B
 JOLTs Job Openings7.4M
 Factory Orders0.2%
 -ex Transport0.5%
WednesdayASP Employment70K
 ISM Services54.5
ThursdayInitial Claims202K
 Continuing Claims1790K
 Nonfarm Productivity0.6%
 Unit Labor Costs2.1%
FridayNonfarm Payrolls80K
 Private Payrolls79K
 Manufacturing Payrolls4K
 Unemployment Rate4.2%
 Average Hourly Earnings0.3% (3.5% Y/Y)
 Average Weekly Hours34.3
 Participation Rate61.6%
 Consumer Credit$10.85B

Source: tradingeconomics.com

In addition, there are three Fed speakers, and I wonder (and am hopeful) that we hear less and less from them going forward.  Obviously, all eyes will be on the payrolls on Friday, and we can dive into that later in the week.  But today, it is hard to get excited about anything.

Good luck

Adf

Pundits and Bores

Posted on by 
The fallout from Warsh’s decision
To leave rates without a revision
Has opened the doors
For pundits and bores
With hawks and doves set for collision

For some, Warsh has failed from the start
As they felt a rate hike was smart
But others explain
That under his reign
It’s markets that play the main part

For a no action outcome by the Fed last week, it certainly is interesting how much digital ink has been spilled discussing the outcome of that meeting and, depending on which side of the argument you fall, whether it was the right move or an error.  You know I have been of the belief that there will be zero rate hikes this year and nothing has changed that opinion yet.

There is a great deal of conversation regarding the Fed’s credibility and how despite Warsh’s tough talk about achieving their 2% inflation goal at his first meeting, by doing nothing last week, he has trashed that credibility.  My first thought here is, given the Fed has failed in its key objective for more than 5 straight years on its own terms, it is difficult for me to accept they had a lot of credibility left to trash.  But my second thought is to listen to the Chairman’s words about allowing the market to do its job, and not simply watch the Fed, and I realize there are an awful lot of analysts and pundits who don’t know how to do that and therefore are extremely uncomfortable now.  As I wrote last week, these folks get paid a lot of money by Wall Street and now they have to earn it.  So perhaps that explains the ongoing diatribes.

Much has been made of the fact that between the June and July FOMC meetings, US Treasury yields rose substantially as you can see from the below chart.

Source” tradingeconomics.com

At the close on Friday, they had risen 34bps in the 30-year and 28bps in the 10-year), although this morning, with oil prices (-5.6%) falling on the back of a renewed diplomatic initiative in Iran, both of those bonds have seen yields back off by 5bps. 

Now, one of the things that Warsh specifically explained in the press conference was that the market had raised rates already, effectively doing the Fed’s job for them.  And here is the point of departure, I believe, regarding the punditry viewpoint and the Warsh viewpoint.  Warsh has been explicit in saying he wants the Fed’s footprint in the markets to shrink.  He wants market participants to, “play the ball, not the referee”.  However, the pundits claim that the only reason rates rose was in anticipation of the Fed hiking rates.  

So, let’s try a little thought experiment.  Assume there was no Fed, instead that money supply was mechanically increased by 2% per year and that all interest rates were determined by the market.  Do you believe that in this scenario, a government running consistent extremely large deficits would not drive interest rates higher than they otherwise would be, without a central bank to officially do so?  I know I do.  Is that any different than the market pushing yields higher because they are concerned with excess supply of Treasuries and other inflation concerns?  

The Fed has had a major, and in Warsh’s (and my) view, too large impact on markets for a long time, since Black Monday in 1987.  Change is hard and the punditry does not like the fact that they are going to have to actually think and pay attention to many variables in order to have a viable view on things, so they are all crying and claiming Warsh is making a huge mistake.  While not surprising, I think they are completely wrong.  

It is also important to understand that the current yields in the bond market are anything but ordinary. Below is a chart I created with FRED data and included the long-term average 10-year yield since 1962, which happens to be 5.81%, more than 100bps above current levels.  For a very long time, a good rule of thumb for the 10-year yield was it should be approximate the nominal GDP growth rate, but we have gone through such a long period of financial repression, that idea faded away.  Perhaps that is coming back into vogue, so at the long-term average, we could see 3.8% GDP growth and 2.0% inflation.  And even today, it could represent 2.7% GDP growth and 2.0% inflation.  I don’t think anybody would be unhappy with that outcome.

My understanding is the task forces will not be reporting until early next year.  At the same time, I am convinced that Mr Warsh is very serious about making significant changes at the Fed going forward, and I applaud that.  But it is going to require him to convince 18 other people who have been inculcated in a process that has proven to be a failure but offers comfort to those people because they know how it works.  Change is very hard, and this will be harder than most.  One last thing, the biggest change is going to be the balance sheet.  The Fed continues to buy T-bills and expand the balance sheet as they continue to seek to maintain “ample” reserves, so banks have liquidity.  I would not be surprised if when we hear from Chairman Warsh at the Jackson Hole meeting at the end of the month, he indicates the Fed will stop buying bills at the next meeting moving further down the path of change.

Surprising comments
Bessent admitted the Fed
Joined the Japanese

The following statement released by Japan’s MOF is quite a surprise, at least the fact that they admitted to the action, something that has rarely been the case in the past.  

Some have made the point that given Japan is the largest holder of Treasury securities in the world (other than the Fed) and that they would need to sell their Treasuries to fund intervention, this was the driving force.  Certainly, the US is not keen to have holders sell their bonds at this point.  As you can see in the chart below, this intervention has had a larger impact than the previous bouts which were solo Japanese efforts.

Source: tradingeconomics.com

At the dollar’s low, the yen appreciated about 5% in the past two sessions, certainly a very large move.  One of the other things that was interesting was that ostensibly, the Treasury sold EURJPY, not USDJPY.  Perhaps they had extra euros lying around they no longer wanted.  According to BOJ data, it appears the Japanese spent something like $33 billion on the intervention, but I have no indication as to the US effort.

Joint intervention is pretty rare, with the last time being in the wake of the earthquake/tsunami at Fukushima in 2011 when the yen strengthened dramatically.  But it also has a better track record than solo intervention, although absent significant fiscal changes, on both sides of this equation, I suspect that within a few months, the yen will weaken again.

Ok, I feel like that’s enough for one morning.  The oil story, as I mentioned, is that the President has called off the mooted weekend attacks and diplomacy is back on the table.  Interestingly, the metals markets are not as excited by that with gold (+0.15%), silver (+0.6%) and copper (+0.75%) all higher, but not by very much, especially given the size of the decline in crude prices.  And product prices (gasoline -3.4%, heating oil -3.0%) are also sharply lower.

As also mentioned above, bond yields have backed off with European sovereigns sliding far more than Treasuries, between -6bps (Germany, Netherlands) and -9bps (UK, Italy, Greece).  However, JGB yields (+3bps) did not get the memo although I suppose that has more to do with the belief that the BOJ is going to be forced to hike rates as part of the joint US-Japanese currency efforts.

As to the equity markets, after Friday’s US rally, the picture in Asia was mixed, despite the oil price decline, although for Japan, a stronger yen is often a problem for Japanese equities.  The worst performers were Korea (-5.1%), Tokyo (-0.9%) and China (-1.0%) while much of the rest of the region followed the US higher (HK +0.5%, India +0.7%, Taiwan +0.6%, Australia +0.5%) with the smaller exchanges mostly higher as well.

In Europe, things are generally bright with Germany (+1.4%), France (+1.3%) and Spain (+0.75%) all nicely higher despite (because of) modestly weaker PMI data although the UK (0.0%) has not been able to overcome its PMI weakness.  Now, in fairness to the UK, its 51.9 reading, while weaker than last month and forecast, is still about the best in Europe.  As to US futures, they are all in the green, led by the DJIA (+0.8%) at this hour (7:00).

Finally, the dollar is kind of confused overall.  The big winner today is KRW (+1.0%) although that trade has been ongoing for more than a month and is approaching an 8% gain over that period.  The yen (+0.4%) continues to climb, albeit less aggressively, although the other G10 currencies are generally under pressure (GBP -0.15%, AUD -0.3%, CAD -0.2%, NOK -0.6%).

However, I must mention something that Alyosha wrote this morning in Market Vibes that is worth considering; two of the major positions in markets were short bonds and short yen.  Joint intervention by the US and Japan to sell EURJPY has likely forced a lot of covering in both of those markets and it would not be surprising to see more activity like that and further short covering.  Japan is the largest holder of French bonds as well as Treasuries and could easily sell those without a peep from the US.  

Ok, I have gone way over my daily quota this morning, although there were a couple of really big, and complex stories to discuss.  On the data front, today brings ISM Manufacturing (exp 54.0) and I will delve into the rest of the week’s data, including Friday’s payroll report tomorrow.

Good luck

Adf

Commit Seppuku

Posted on by 
Alas, nothing’s changed in Iran
And feces is hitting the fan
So, pundits feel strongly, 
Although I think wrongly
A rate hike is part of the plan

In fairness, the bond market, too
Is on board, that ere July’s through
The Fed will have raised
Won’t they be amazed
If Warsh won’t commit seppuku?

Yesterday’s dominant theme was the fact that oil prices had risen so aggressively with WTI above $90/bbl and Brent touching $100/bbl.  Interestingly, both are lower this morning, WTI (-2.5%) and Brent (-2.7%) and both are back below those big psychological levels despite no seeming changes on the ground in Iran.  The Houthis are still causing trouble in the Bab al Mandeb, the US is still attacking sites along the Persian Gulf and there are no peace discussions ongoing.  A headline in the WSJ this morning explained, Trump Is Losing Patience Over an Iran War With No Clear End in Sight.

But really, the bigger discussion has been about US yields (and correspondingly global yields) as they continue to head higher.  Below is a screenshot from Bloomberg showing the yield curve and how yields have changed in the past month and year.

There has been quite a bit of digital ink spilled over the concept that short-dated T-bills have now priced in a rate hike next week, as per Wolfstreet.com,

“The 2-month Treasury yield spiked by 13 basis points today and by 15 basis points during the week to close at 3.95%, according to Treasury Department’s yield calculation. This is at the upper end of the Fed’s target range after it hikes by 25 basis points, which would bring its target range to 3.75%-4.0%. And it is 32 basis points above the Effective Federal Funds Rate (EFFR, blue), which the Fed targets with its policy rates. This is a stunning move, pricing in a “surprise” rate hike at the FOMC meeting next week.”

And here is his accompanying chart.

Of course, what makes all this so juicy is that Chairman Warsh has gone out of his way to end forward guidance so market participants are now left to their own devices to determine what the Fed may do, something most of them have either forgotten, or never knew, how to do.  

Let’s consider, for a moment, some potential outcomes and the rationales behind them.  First, it is critical to remember that Warsh needs a majority of the voters, so at least 7, to get to a result.

  • No change (poet’s estimated probability 90%) – the most recent inflation data, both CPI and PPI were much cooler than expected thus offering significant cover to leave policy on hold.  Add to that the fact that the task forces will not have completed their work and report on anything.  This means Warsh can reasonably say, before we do anything, let’s make sure we are looking at things that are fit for purpose.  One last thing to recall is that if energy prices are the driver, raising interest rates will not produce more energy, so it is the wrong action to solve the problem.
  • 25bp hike (10% probability) – while there have been several FOMC members who discussed the needs for hiking rates as inflation was becoming uncomfortably high, I don’t believe that contingent is large enough to make up a majority, especially of voters.  In addition, the history of central bank rate hikes into energy price spikes is replete with disasters across the board.  After all, the same pundits who are calling for a hike explain that rising energy prices are like a tax and weaken economic activity.  Certainly, the Treasury market price action indicates there are many who believe a hike is coming and if we look at Fed funds futures markets, the probability is higher than mine at about 30% as per the below chart from cmegroup.com, but look at how much that has changed over the past month.  My point is that there is no consistency of view.
  • 50bp hike (NO CHANCE) – there is a group in the analyst community who are calling for a shock maneuver of a 50bp hike.  The rationale seems to be that this would burnish Warsh’s hawkish credentials, and the bond market would rally on the news.  But even if he wanted to do this, and I don’t think that is the case at all, it would require him to get six others to go along.  There is no way that type of viewpoint exists on the committee, I am convinced.  This is clickbait in my view, analysts making outlandish calls so people will read their stuff.

In the meantime, though, yields do continue to rise around the world.  While this morning, they have backed off from yesterday’s recent highs (UST -1bp, bunds -2bps, gilts -4bps, OATs -3bps, BTPs -3bps), they remain just below levels not seen in several years.  One interesting thing about the European sovereign market is the fact that yields in Greece (3.90%) are lower than in either France (3.99%) or Italy (4.01%).  It wasn’t that long ago that Greece was the poster child for fiscal profligacy and lived through a depression.  But give them credit, they learned and now run a primary surplus in their fiscal account, something not seen in many other nations these days, certainly not the US, France or Germany.

But rising rates are wreaking havoc with equity markets, and that has become another fiscal problem since tax receipts from capital gains is such a significant part of the tax base these days, at least in the US.  So, yesterday’s desultory performance in the US, led lower by the NASDAQ’s -2.15% decline, was followed with a similarly negative feeling in Asia (Tokyo -2.7%, China -1.7%, HK -1.0%, Korea -5.7%, Taiwan -2.7%) with the similarity that they are all tech focused.  But weakness in the region was virtually universal, albeit not as dramatic.

In Europe, though, things are looking better after very solid Flash PMI data across the board.  So, Germany (+0.7%) is leading the way higher along with Spain (+0.8%) although France (+0.3%) and the UK (+0.1%) are also in the green, with the latter despite the fact that new PM Burnham is already discussing raising property taxes.  As to US futures, at this hour (7:30) they are marginally higher.  Despite yesterday’s angst, the NASDAQ has not been able to breach the key support level I am watching, as per the below chart.  (If it does, I will be looking to buy QQQ puts, but we shall see if that happens.)

Source: tradingeconomics.com

Briefly regarding metals markets, with oil under pressure today, we cannot be surprised that the metals markets are climbing with gold (+0.2%), silver (+1.2%) and copper (+0.1%) all in the green.  Earlier this week it appeared that relationship may have broken, but it has reasserted itself for now.

Finally, the dollar is little changed this morning, perhaps slightly softer.  But it has rallied over the past week alongside yields as per the below chart of the DXY.

Source: tradingeconomics.com

The major outlier today is KRW (+0.9%) although that is simply an ongoing extension of the central bank’s efforts to add liquidity and internationalize the currency.  Thus far, it has been pretty successful, at least their discussions of the process.  Since things don’t really change until January 2027, I guess we will need to wait until later to find out if it holds up.

But I also wanted to mention the yen (0.0%) which yesterday touched yet another new 40-year low (dollar high).  I have created a chart of USDJPY from FRED data so you can get a sense of how quickly the yen appreciated back then in the wake of the Plaza Accord.  The red circled area down leg took place almost entirely in June 1986.

And that’s pretty much it.  On the data front we get Flash PMIs (exp Manfacutring 54.3, Services 51.5) and New Home Sales (610K).  Once again, we are at a summer weekend so I expect that by noon, things will really slow down.  I don’t believe today’s data will have an impact, and I expect a pretty dull day overall.  Arguably, until the FOMC, absent a major turn in the Gulf, things should remain fairly stagnant as there is no data of note to change opinions. 

Good luck and good weekend

Adf

Some Heartburn

Posted on by 
Chairman Warsh, to the House, testified
And explained that his tolerance died
For higher inflation
Throughout this great nation
And ‘bout this, he will not backslide

But prior to his starlike turn
Investors and markets did learn
That CPI fell,
Though not a death knell,
And caused, for rate hawks, some heartburn

It is better to remain silent and be thought a fool than to speak and remove all doubt. – Abraham Lincoln

The attributed saying above, while not certain that it was uttered by President Lincoln, still makes its point eloquently, as well as somewhat humorously.  And I strongly believe that every member of the FOMC should take it to heart before they speak.  In fact, they should be thanking Chairman Warsh for his efforts to shut them up, because then they won’t sound quite so foolish.

For instance, just Monday, Governor Waller, in a speech in New York, finished with the following line, “But I don’t take the inflationary signals I have discussed today lightly. If we get another hot reading on core inflation this week, then the FOMC will need to consider tightening monetary policy in the near term.”  Oops!

And this is one of the issues because many believe that the FOMC gets the data earlier than the release date and so have inside information.  Thus, when Waller talks about the risk of a hot print, many think he knows something.  And this is yet another reason that ending forward guidance and reducing the commentary of the FOMC will be valuable.  

By now, I am sure you are aware that yesterday’s CPI reading was the largest downside miss since Covid in 2020, with the headline number falling -0.4% on the month and the annual slipping back to 3.8% while the core number was flat with the annual falling to 2.6%.  Now, as the Inflation Guy explains, this was the product of numerous subcomponents declining, not just the price of oil/gasoline and this is not the venue to discuss them (read the link).  

But it certainly helped Chairman Warsh in the timing of his testimony as nobody there could ‘blame’ him for still rising prices, at least for now.  As expected, several House members tried to get interest rate information from him, but he remains firm that the Fed’s mission is to drive inflation lower and this will be done through both interest rate and balance sheet policy changes, not through forward guidance.

It is not surprising that the market responded dramatically with the following chart from Polymarket (taken from Kobeissi on X) showing an impressive change of heart.

While I use the Fed funds futures chart from the CME as my guidepost, there is something to be said for the wisdom of crowds here.  Remember, this is a binary call, not a gradient one.  But even the futures markets adjusted significantly, and rightly so, with the probability of a July hike there falling to 16% from 40% when I wrote yesterday morning.  As well, while there is still more than one rate hike priced for 2026, the calculated change has declined to 33bps from 43bps yesterday morning.

Source: cmegroup.com

Skepticism remains rife regarding Chairman Warsh and his attempt to change the way things are done at the Fed, but personally, I am quite optimistic that he is attacking the real problems.  Remember, the Fed is a 114-year-old institution with an extremely long memory and a staff that, like most of government, believes they know what is best for others.  I strongly subscribe to the monetarist view that printing more money leads to more inflation, but making a change that dramatic all at once is just not possible.  Let us be thankful that Chairman Warsh appears to have a better understanding and is working to change things.  And remember, he has only been in the Chair for two months, give him some time.

As I start to recap markets, it is quite interesting that the price of oil seems to have decoupled from the war in Iran.  I say this because as I type at 7:15, a bit more than an hour after CentCom explained they had instituted another wave of military attacks on Iran, WTI is largely indifferent to the news.  While it has edged higher by 0.7%, a look at the chart below of the past 24-hours shows essentially no response.

Source: tradingeconomics.com

So, let’s turn to equities, which rallied on the CPI data in the US yesterday and saw follow through in Asia with Tokyo (+1.5%), HK (+1.4%) and Korea (+6.25%) all having strong sessions as did almost every market in the region.  However, there was an exception, China (-0.2%) which while not disastrous, substantially lagged other markets.  Arguably, the proximate cause of that disappointment was the disappointing data released last night as per the below:

Source: tradingeconomics.com

Certainly, GDP at 4.3%, below even Xi’s reduced target must be concerning and Fixed Asset Investment (housing) continues to crumble.  It is very difficult to look at this data, as well as their monetary data which, for instance, shows loan growth not merely trending lower, but doing so at an accelerating rate as per the below chart and conclude things are going will there for the economy or the equity markets.

Source: tradingeconomics.com

Europe, though, continues to lag with all the major bourses lower as the DAX (-0.8%) leads the way followed by Spain (-0.6%) and then France and the UK both slipping -0.2%. (I guess World Cup results are not indicative of their equity markets!). As to US futures, at this hour (7:25) they are all up very slightly.

Bond yields fell yesterday, notably the 2yr slipping -6bps, while the 10yr only fell -3bps.  This morning, though, yields are edging back higher with Treasury yields up 2bps and European sovereign yields higher by between 3bps and 4bps.  While equity markets remain sanguine about Iran, it seems bond markets are having a tougher time.  JGB yields (-2bps) are bucking the trend as there are still those who are looking for Japanese pension funds to start bringing more money home.

While the metals markets rallied yesterday, this morning they are under pressure again with gold (-0.6%) and silver (-1.2%) giving back yesterday’s gains while copper (-0.3%) is consolidating after jumping a dime yesterday.

Finally, the dollar is sidelined this morning with no notably large movements in either the G10 or EMG blocs.  A brief word on the yen, which has certainly been the subject of much digital ink spillage lately, as it seems all those thoughts of the pension fund support for the yen are not part of the FX conversation.  We remain less than 50 pips from the peak seen back on June 30 and I see very little reason for the broader trajectory to change.  The BOJ is not going to waste its reserves in this process, and given the gradual movement, I don’t think they are that upset.  As long as PM Takaichi is planning to spend more money, whether on infrastructure or investment, given they are borrowing all of it, a strong yen seems highly improbable.

On the data front, this morning brings PPI (exp 6.2% headline, 5.2% core) and the Empire State Manufacturing Index (8.8) at 8:30.  Then, at 9:45 the BOC will most likely leave their base rate on hold at 2.25% and at 10:00, Chairman Warsh will testify to the Senate Banking Committee.  We also get the Fed’s Beige Book this afternoon, EIA oil inventories and three more Fed speakers, although with Warsh speaking, will anybody care?  Especially since they continue to make fools of themselves with their own forward guidance.

The most remarkable thing to me is how insouciant market participants have become despite increased hostilities in the Gulf.  But both oil and equity traders have seemingly decided that other things matter more.  With that in mind, it is hard to get excited about too much these days.  Unless we see markets breaking their recent ranges, in either direction, I suspect that the weight of summer, and reduced liquidity is going to prevent anything substantial from happening anytime soon.

Good luck

Adf

Subterfuge

Posted on by 
The narrative right now is run
By hawks who think Warsh is the one
To raise short-term rates
Right out of the gates
And so, they’re long bucks by the ton

Thus, futures positions are huge
With no effort at subterfuge
But if they are wrong
About being long
The hawks will have all been the stooge

In an otherwise quiet session, this morning I am going to borrow from Ole Sloth Hansen, the futures maven at Saxo Bank.  He publishes a Substack that is well worth reading if you are actively involved in the markets as he breaks down futures positions and offers context.  This morning I am going to juxtapose those positions with my views, which are diametrically opposed to the way the market is currently positioned.

Starting with the FX market, he has created a wonderful chart showing that the net non-commercial long USD position against eight major currencies has reached 10-year highs.  Interestingly, the DXY is not anywhere near those highs, although it appears that is the growing expectation of many traders.

Arguably, this is based on the idea that Chairman Warsh is Paul Volcker redux and will be quite hawkish going forward.  Now, I cannot tell if this is the narrative because, absent forward guidance, narrative writers must now think on their own and are incapable of doing so, or if they truly believe that despite all the talk that rising oil prices were going to feed through to inflation readings, declining oil prices won’t have the same impact on the way down.

But it is not just the FX trading community that is on board with this story, so too is the short-term interest rate trading community.  While LIBOR has been forced out of existence, SOFR (Secured Overnight Funding Rate) is the new benchmark in interest rate markets and, naturally, there is an active futures market there as well.  As you can see from the below chart, also from Mr Hansen, the current positioning is strongly expecting higher short-term interest rates.

This is completely in accord with the Fed funds futures market where the market continues to price a 25% probability of a hike at the end of July and a virtual certainty of a hike by October.  By my calculations, as per the chart from cmegroup.com below, the market is pricing about 30bps of rate hikes by the December meeting.

Or course, by now you know that my view is the Fed will not be hiking rates at all, and as measured inflation slides back (just look around the world and at oil prices) the narrative will belatedly shift to the need willingness to reduce rates on Warsh’s part and all these market positions will adjust.  

My longer-term positive view of the dollar is based on the ongoing investment inflows into the US, for real investment, not merely equity market participation, and nothing has happened to change that view.  In fact, the announcement yesterday by Toyota that they will be expanding their San Antonio truck and SUV plant with a $3.6 billion investment is just the latest in a series of these announcements.  But that is not the carry trade driving things.  In fact, ironically, we could easily see US rates slide a bit as the dollar rallies on natural investment demand rather than financial demand.  As well, if I am correct, the Fed funds futures market is going to head back to pricing no rate hikes, perhaps as soon as next week after the CPI data is released.

I think the lesson is that the narrative writers need to bone up on their understanding of macroeconomics and international finance as the central bank policy driver may not be the future.  Certainly, if Mr Warsh has anything to say about it, and he does, that will likely be the case.

Which takes us to the overnight session. The most excitement overnight was for Belgium as they completely outplayed the USMNT in a 4-1 victory in Seattle.  But otherwise, the story that Iran fired two missiles at ships heading through Hormuz helped support oil prices, but as I type, they are higher by just 0.7% (~50¢/bbl) so not really very much.  The interesting discussion in the oil market this morning is the fact that Iranian oil, which is no longer sanctioned, cannot seem to find any buyers with some 58 million barrels in floating storage and no takers.  Meanwhile, despite ongoing buying by central banks around the world, gold (-0.5%) continues to struggle, although appears to be putting in a base and silver (-1.4%) is suffering as well.  

In the bond market, yields are creeping higher with both Treasuries and European sovereigns all higher by 2bps this morning with a similar move by JGBs overnight.  My take is this is less of an inflation concern than a supply concern.  Certainly, there is no indication that the US, Europe or Japan are about to slow down their fiscal stimulus, with Europe now further ramping up its defense spending as the US pressures NATO further.  To me, this is where the rubber will meet the road as if Warsh really does seek to reduce the Fed’s balance sheet, it is not clear where buyers are going to be found to replace them.  I suspect we will see more regulatory freedom for banks and insurance companies to hold Treasuries without capital penalties, but that is a big hole to fill.  

In the equity markets, yesterday’s US rally was followed by a reversal in Asia with Korea (-4.9%) leading the way lower on the back of weakness in SK Hynix stock despite stellar earnings.  But that dragged down the entire region (Japan -2.1%, China -1.0%, HK -0.5%, Taiwan -2.3%) and various declines everywhere else except Singapore (+1.4%) although I can find no specific catalyst for that outlier move.  In Europe, things are more mixed with Germany (-0.7%) under pressure although there is modest strength in the UK (+0.3%), France (+0.2%) and Spain (+0.1%).  All the talk here is about defense spending, although one would have thought that would help Germany the most.  As to US futures, at this hour (7:55), NASDAQ futures are following Asia lower, -1.3%, but the other indices are little changed.

Finally, the dollar is generally a bit stronger this morning, at least against its G10 counterparts, although JPY (+0.1%) is holding up.  But the dollar’s gains are minimal, about 0.1% to 0.2%, so it is difficult to get too excited.  In the EMG bloc KRW (+1.0%) is the clear leader after the country expanded trading hours in the currency markets, and there has been modest strength in BRL (+0.4%) and INR (+0.4%) although neither has seen any major policy changes.

On the data front, yesterday’s ISM Services data was right on the button at 54.0.  This morning we see the Trade Balance (exp -$78.5B) and that’s it.  The hawkish Fed story continues to be the most popular, and until we see some data that can undermine that story, I expect it will remain in place.  Tomorrow’s FOMC Minutes should be interesting as there was obviously a lot of back and forth at the meeting, but since we have already heard further from Mr Warsh, and it is way too early to hear back from the task forces, I suspect we are in for more quiet markets for now.

Good luck

Adf

My House

Posted on by 
Said Kevin, the Fed’s now MY house
And views that we choose to espouse
Will no longer guide
So, when we decide
To move, we expect some to grouse

As well, we are set to review
Our policies all the way through
So, comms will be changed
And data arranged
In truth, it is quite the to-do

This is an evening note as I will be unavailable to write tomorrow morning as we head off to show GCH Nubia’s Take Your Breath Away, aka Marvel to a show.  That is his handler and the judge who awarded him Best of Breed that day.

But not surprisingly, the only thing that really mattered today was the FOMC meeting.  I have to say, having watched the entire press conference I am really impressed with Chairman Warsh.  I love the fact that he shortened the statement and that they are ending forward guidance.  And it was quite interesting that half the reporters’ questions were trying to get guidance about what the Fed may do in the future, despite him repeating that there was no more forward guidance.  My take is Fed reporters are going to have to learn about how markets work and more importantly, market practitioners are going to make up their own minds rather than rely on the Fed to bail them out.  This is all really positive!

The most noteworthy thing was the creation of five task forces to address issues with the way the Fed currently does things on the following subjects:

  1. Communications
  2. Balance Sheet
  3. Data Sources
  4. Productivity and Jobs
  5. Inflation Framework

So, it strikes me that Chairman Warsh is going to look to reprogram the Fed, something that has been sorely in need.  Do not be surprised when much of the commentary is negative on these subjects because those are the folks who benefitted from the old way of doing things.  They now need to change their models and their narratives and they are unhappy.  Another benefit.

The upshot of the meeting was that rates were left on hold and the dot plot, where Warsh did not supply a dot, showed that half the committee thought rates appropriate, and half thought they would be higher by the end of the year.

Of course, this largely jibes with the Fed funds futures market as you can see in the latest table from the CME.

Of course, looking at this table, something seems amiss for September, perhaps there was a large position put in place that drove the market.  At any rate stock markets were unhappy with the major indices slipping -1.0% or more after the FOMC although bonds did very little and commodities continue to show oil slipping while gold and silver rise.  As to the dollar, it rallied pretty much across the board.

It is way too early to anticipate exactly how things are going to play out, but I am encouraged.  I strongly believe a little price volatility is a small price to pay to reduce systemic risk by reducing leverage in the system, and that is very likely to be the outcome if Mr Warsh has his way.  My forecast is the “ample reserves” balance sheet program is going to change before he is done.  If that is the case, I think they will have a real opportunity to get inflation under control.  As well, I believe that prospect will undermine much of the ‘death of the dollar’ narrative.  It truly will be significant.  We shall see.

Good luck

Adf

Future With Dread

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

Source: tradingeconomics.com

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

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

Good luck

Adf

Changing the Fate

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

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

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

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

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

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

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

Data: streetstats.finance

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

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

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

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

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

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

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

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

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

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

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

Source: tradingeconomics.com

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

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

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

Source: tradingeconomics.com

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

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

Good luck

Adf

The Abyss

Posted on by 
This month has seen traders dismiss
The idea that risk led to bliss
Stocks worldwide have fallen
And those who were all in
With leverage now face the abyss

But it’s not just war in Iran
That’s scrambled most everyone’s plan
The data, as well
Are heading to hell
With no central banking wise man

As I didn’t write on Friday, and it seems some things happened while I was away, I thought I might offer my views of where things stand as we enter the new week.

🤯🤯 😱😱 🤮🤮

I think that sums it up nicely.

Recapping the end of last week quickly, all the central banks left policy on hold, as was expected with all showing a more hawkish lean given the dramatic rise in energy prices, so far, and fears that food will follow shortly.  The BOE was the most obvious as rather than a 5/4 vote with 4 votes for a cut, it was 9/0 for no movement.  Adding the Thursday decisions to the previous ones from the week, and looking at the Fed funds futures market, the two tables below from cmegroup.com show the change over the past month from modest expectations of a cut at the next meeting to modest expectations of a hike, first:

Then, if we look at the aggregated probabilities, you can see that the market has priced out any cuts for 2026 at this stage, with nothing, really, until the end of 2027.

Now, here’s the thing about this pricing.  It is a current estimation based on the Fed funds futures curve and certainly is subject to massive change going forward.  However, other markets that rely on interest rate cues see this and respond accordingly.

For instance, the 2-yr Treasury note (gray line) also has seen a major yield rally as you can see in the chart below and now sits above Fed funds effective (blue line) for the first time since late 2022 when the Fed finally caught up in its race against the raging inflation of the time.

Source: tradingeconomics.com

So, inflation is once again a major worry of the markets, and investors have come to believe that central banks are not going to be coming to the rescue for their risk assets as their hands will be tied by higher energy prices driving headline inflation higher.  Of course, we all know that central banks raising rates will not adjust short term price inelasticity for energy products, although it could well cause a deep recession which would likely have an inflation impact.  But my take is, that is not their goal either.

And that is why everyone is so unsettled.  The idea that the central banks are going to come to the rescue of risk assets has been killed and now the pricing of those assets needs to rely on their own fundamentals, a much tougher task historically.  

This is especially so given the data from Thursday showed PPI much hotter than expected, which adds to the narrative that the Fed, and other central banks, are on hold, at best, if not getting itchy to hike rates.

With this in mind, we cannot be surprised that equity markets suffered greatly on Friday, as did bond markets and precious metals.  However, I believe the drivers of equities are different than those of the traditional havens of bonds and gold.  In the case of equities, high valuations, which have existed for a long time, and significant leverage, with margin debt at record highs, although as you can see from the chart below, I created from FINRA data, it turned down ever so slightly in February have started to take their toll.

And in fact, that toll on margin debt is being played out in both bonds and gold as both are clearly feeling the effects of massive deleveraging as hedge funds and CTAs all scramble to make their margin calls.  In this case, they sell what they can that is liquid, not what they want to sell, so bonds and gold fit the bill.  My take is if the war continues very much longer, we will see the margin selling diminish and soon, both gold and bonds are going to seem like pretty good places to hide.  (Now, if you want to keep up with inflation, USDi, the fully-backed inflation tracking crypto currency available at www.usdicoin.com) is going to do so far better than short-term interest rates which are almost certainly going to lag inflation for a while going forward!  Ask me about this and I am happy to discuss.)

And that’s all I have this evening.  There is a great deal of back and forth with threats from both sides in the war, and whether or not the Iranian electricity infrastructure is hit, or if their nuclear power plant at Bushwehr is hit and if so, how they retaliate remains unknown and fodder for the narrative writers.  I have no opinion other than I hope none of that happens.

In the meantime, risk reduction is likely to continue as equities suffer while the dollar maintains its value and oil is the real risk, as any indication that the military action is ending is likely to see a major downdraft there.  Unless you are a professional trader, with real capital behind you and a great market and news feed, this is not a time to play in my view. However, if I look at things and where they currently sit as Sunday night opens, gold seems to be too cheap.  For millennia it has served as the last recourse of safety, and I do not believe this war will be any different than any of the countless wars in the past.  This doesn’t mean it cannot go lower, just that it probably is approaching a place of ‘value’ especially as you can be sure that at some point later this year, every central bank will be printing as fast as they can if economies start to stutter.  One poet’s thought.

Let’s see what happens overnight and I will be back again tomorrow.

Good luck

Adf