Tag Archives: federal-reserve

Bears’ Chagrin

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The talk of the town is the Fed
And who Mr Trump will embed
As governor, next
Amid a subtext
That Powell, by May, will have fled
 
Meanwhile, other stories are muted
As tariffs’ impact seem diluted
And earnings have been,
To most bears’ chagrin,
Much better than had been reputed

 

Yesterday was a modest down day in equities, although the trend remains clearly higher at this point as evidenced by the chart below.  As well, the price action remains well above the 50-day moving average, a key technical indicator defining the trend, with no indication it is set to retrace there.  As of this morning, we are sitting about 2.5% above that average, so a decline of that magnitude will be necessary to get tongues wagging about a change.

Source: tradingeconomics.com

This is not to say that everyone is sanguine about the situation as just yesterday, three investment banks, Morgan Stanley, ISI Evercore and Deutsche Bank, all put out research calling for a retracement in the near term.  Certainly, the recent data has been mixed, at best, with still a lot of discussion regarding last Friday’s weak NFP data.  Meanwhile, the ISM Services data was weak (50.1 vs 51.5 expected), while the PMI Services was strong (55.7 vs 55.2 expected).  

Corporate earnings continue to be solid, with about two-thirds of the S&P 500 having reported Q2 numbers and 82% have beaten EPS estimates, higher than the recent 5-year average, and the growth rate at 10.3% on a quarterly basis.  This does not seem indicative of the recession that many continue to claim is ongoing or imminent.

But let us take this time to briefly consider both sides of the argument regarding the future of the economy, and by extension financial market activity.

On the plus side, while the NFP number was soft, the Unemployment rate remains at 4.2%, in the lowest quintile since 1948 as per the below chart.  

As well, Initial Claims data, the most frequent labor market data that is available, remains at the 13thpercentile, an indication that despite a great deal of concern by a certain segment of analysts, the labor market is still pretty strong.  In fact, the last time Initial Claims was this low during a recession, in 1970, the US population was about 205 million compared to today’s 340 million.  After all, this has been the issue on which Powell has been hanging his hat, and why Friday’s NFP number changed the narrative regarding the Fed.

The most recent GDP data was also quite positive, with Q2 growing at 3.0%, better than expected and then yesterday we saw the Trade deficit shrink to -$60.2B, its smallest level since September 2023.  Trade, though, is a double-edged sword as a smaller deficit could indicate weaker domestic demand, or it could indicate stronger domestic supply.  Naturally, this is the president’s goal, to achieve the latter, hence his tariff blitz.

As to inflation, it is off its recent lows, and remains well above the Fed’s 2.0% target, but with core CPI at 3.0%, it is hardly hyperinflationary.  The tariff impact remains uncertain at this point as so far, it appears many companies are eating a significant portion.  I guess that will become clearer in the Q3 earnings reports, although analysts continue to forecast strong growth there.  

So, across jobs, growth and inflation, there is a case to be made that things are doing fine.  Add to this the idea that fiscal stimulus is unlikely to end, merely be redirected from the previous administration’s favorites to this one’s, and you can understand the view that things are pretty good.

However, the other side of the story continues to have many adherents as well.  Most of the negative outlook comes from digging underneath the headline numbers and extrapolating out to the negative trends that may exist there blooming into the full story.

For instance, regarding employment data, while the headlines have been ok, ISM Manufacturing Employment has fallen to 43.4, its lowest level in more than 5 years and pretty clearly trending lower, even on a cyclical basis as per the below chart.

Source: tradingeconomics.com

Too, ISM Services employment has fallen to 46.4 (anything under 50.0 indicates recession-type weakness). NFIB Employment surveys are negative, with small businesses planning to create fewer jobs in the next three months as per the below chart from the NFIB July report.

Challenger job cuts are rising again, with much of the blame put on AI.  JOLTS Job Openings have been trending lower since Covid, but it is difficult to really tell there, as the levels are far above pre-Covid data as per the below BLS chart.

There is also a hue and cry that the deportations are removing a significant number of manual workers in fields like construction and agriculture, which is likely true.  However, as I highlighted earlier in the week, the mix of employed in the US has turned to a greater proportion of US-born workers vs. foreign-born workers with net growth.  So, perhaps many of those jobs are being filled anyway.

From a GDP perspective, the economic bears tend to dig into the pieces and have focused on declining consumption data although Retail Sales continues to motor along pretty well, rising 5.3% in the past twelve months when looking at the control group (excluding food services, auto dealers, building materials and gas stations) which is what is used in the GDP data.  I am hard-pressed to look at the below chart and explain a dramatic slowing in growth.

Source: tradingeconomics.com

As to inflation, there continues to be a strong set of beliefs that tariffs are going to create a significant uptick, although it has yet to appear.  ISM Prices paid did rise in Services, to 69.9, their highest level since the retreat from the 2022 “transitory inflation”.

Source: tradingeconomics.com

However, ISM Manufacturing prices appear to be stabilizing after some recent increases.  The overall ISM price data is more worrisome as tariffs are only going to be on goods, and if services prices are rising, that is likely to feed through to general inflation more directly.  

Concluding, we seem to be an awful long way from stagflation that some analysts are calling for as growth continues apace and there is no indication that fiscal stimulus is going to end.  Rather, I would expect that we will see overall hotter growth, with higher prices coming alongside, and likely higher wages as well.  I still have trouble seeing the collapsing US economy story, although things are hardly perfect.

And how will this impact markets?  Well, broadly, while equities have clearly had an impressive run, and the trend is your friend, a pullback would not be a huge surprise.  But dip buyers will be active, of that you can be sure.  

As to bonds, if the US does run things hot, unless the budget deficit starts to shrink substantially, with the next release coming on August 12, yields are very likely to continue to remain bid.  Right now, the curve is steepening because traders are banking on the Fed to cut next month so the 2yr yield has fallen sharply.  But if growth remains strong, I would say there is a floor to yields although absent a significant rise in inflation, I don’t see them exploding higher either.  And if the BBB actually does generate more revenue and reduce the budget deficit, look for yields to decline anyway.  

Finally, the dollar should do well unless the Fed become aggressive.  That story is too difficult to forecast given the machinations on the board and the questions of who the next Fed chair will be.  As I have written before, in the short and medium term, a dollar decline is quite viable, but long term, most other nations have much bigger problems than the US, and I think investment will ultimately flow in this direction.

My apologies for the length of the opening and given the fact that there is so little happening in markets, with just a little back and forth, I will skip the recap.

Good luck

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Full Schmooze

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The temperature’s starting to fall
With Israel and Iran’s brawl
On hold for the moment
Though either could foment
Resumption, and break protocol
 
But that truce combined with the news
That Trump’s team are pushing full schmooze
On trade, has the markets
Increasing their bull bets
While skeptics are singing the blues

 

President Trump is having a pretty remarkable week.  The successful attack and destruction of Iran’s nuclear enrichment facilities combined with the news that the US and China have agreed the details of the trade framework that was outlined in Geneva and followed up in London has market participants feeling a lot better about the world this morning.  Add to that the news that a particularly onerous part of the BBB, Section 899, which was nicknamed the Revenge clause for its tax targeting anybody from nations that imposed excess taxes on US companies internationally, being stripped after negotiations with European leaders, and the fact that NATO has gone all-in on increasing their spending, and Mr Trump must be feeling pretty good this morning.  Certainly, most markets are feeling that, except those that thrive on chaos and fear, like precious metals.

In fact, this morning it seems that the entire discussion is a rehash of what has occurred all week with very little new added to the mix.  Data from the US yesterday was mixed, with Claims a bit softer and Durable Goods quite strong while the third look at Q1 GDP was revised lower on more trade data showing imports were greater than first measured while Consumer Spending and Final Sales were a bit weaker than expected.  Net, there was not enough to push a view of either substantial strength or weakness in the economy, so investors and their algorithms continue to buy shares.

The other story that continues to get airplay is the pressure on Chairman Powell and questions about whether at the July meeting Fed governors are going to vote against the Chairman.  Apparently, it has been 32 years since that has occurred (and you thought they were actual votes!) and the punditry is ascribing the dissent to politics, not economics.  It should, of course, be no surprise that there is a political angle as there is a political angle to every story these days, but the press is particularly keen to point out that the two most vocal Fed governors discussing rate cuts were appointed by Trump.

However, despite all the talk, the futures market does not appear to have adjusted its opinion all that much as evidenced by the CME chart of probabilities below.  In fact, over the past month, the probability of a cut has declined slightly.  Rather, I would contend that on a slow news Friday, the punditry is looking for a story to get clicks.

The last story of note is about the dollar and its ongoing weakness.  This is an extension of the Fed story as there is alleged concern that if the Fed is perceived to lose some of its independence, that will be a negative for the dollar in its own right, as well as the fact that the loss of independence would be confirmed by a rate cut when one is not necessary (sort of like last autumn prior to the election.  Interestingly, I don’t recall much discussion about the Fed’s loss of independence then.)

But, in fairness, the dollar has continued to decline with the euro trading to its highest level, above 1.17, in nearly four years.  It is hard to look at the story in Europe and think, damn, what a place to invest with high energy costs and massive regulatory impediments, so it is reasonable to accept that what had been a very long dollar position is getting unwound.  But look at the next two charts (source: tradingeconomics.com) of the euro, showing price action for one year and for five years, and more importantly notice the trend lines that the system has drawn.  There is no doubt the dollar is under pressure right now, but I am not in the camp that believes this is the beginning of the end of the dollar’s global status.  Remember, too, that President Trump would like to see the dollar soften to help the export competitiveness of the US, and so I would not expect to hear anything from the Treasury on the matter.

However, while these medium and long-term trends are clear, the overnight session was far less exciting with the largest move in any major currency the ZAR (+0.5%) which is despite the decline in gold and platinum prices.  Otherwise, today’s movement is basically +/- 0.2% across both G10 and EMG currencies.

Speaking of the metals, though, they are taking it on the chin this morning as we approach month end and futures roll action.  Gold (-1.3%), silver (-1.7%), copper (-0.9%) and platinum (-4.4%) are all under pressure, although all remain significantly higher YTD.  However, to the extent that they represent a haven and the fact that havens seem a little less necessary this morning seems to be the narrative driver adding to the month end positioning.  Meanwhile, oil (+0.5%) continues to bounce ever so slowly off the lows seen immediately in the wake of the bombing attacks.

Circling back to equity markets, after a nice day in the US yesterday, with gains across the board approaching 1% and the S&P 500 pushing to within points of a new all-time high, Japan (+1.4%) followed suit as did much of the region (India, Taiwan, New Zealand, Indonesia) but China (-0.6%) and Hong Kong (-0.2%) didn’t play along.  Europe, though, is having a positive session with gains ranging from 0.65% (DAX) to 1.3% (CAC) and everything in between.  It seems that the NATO spending news continues to support European arms manufacturers and the cooling of tensions in the Middle East has lessened energy concerns.  US futures are also bright this morning, up about 0.5% at this hour (7:40).

Finally, bond markets are selling off slightly after a further rally yesterday and yields since the close have risen basically 3bps in both Treasury and European sovereign markets.  There is still no indication that any government is going to stop spending, rather more increases are on the horizon, but there is also no indication that central banks are going to stop supporting this action.  No central bank is going to allow their nation’s bond market to become unglued, regardless of the theories of what they can do and what they control.  Ultimately, they control the entire yield curve.

On the data front, this morning brings Personal Income (exp 0.3%), Personal Spending (0.1%) the PCE data (Core 0.1%, 2.6% Y/Y; Headline 0.1%, 2.3% Y/Y) and at 10:00 Michigan Consumer Sentiment (60.5) and Inflation Expectations (1yr 5.1%, 5yr 4.1%).  There are several more Fed speakers, including Governor Cook, a Biden appointee who is a very clear dove, but has not yet agreed that rate cuts make sense.  It will be interesting to see what she has to say.

It is a summer Friday toward the end of the month.  Unless the data is dramatically different than forecast, I expect that the dollar will continue to slide slowly for now, although I do expect the metals complex to find a bottom and turn.  As to equities, apparently there is no reason not to buy them!

Good luck and good weekend

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Not Yet Foregone

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The US has not yet been drawn
To war, though it’s not yet foregone
That won’t be the case
While Persians now brace
For busters of bunkers at dawn
 
But until such time as we learn
That outcome, the current concern
Is Jay and the Fed
And what will be said
At two o’clock when they adjourn

 

So, every top headline this morning discusses the idea that President Trump is considering whether to initiate US military action in Iran, specifically to drop the so-called bunker buster bombs to destroy Iran’s nuclear enrichment and bomb-making facilities.  There is certainly a lively discussion on both sides of the argument with the best description of the problem that I’ve seen being a poll showing that 74% approve Trump’s position that Iran must not get nuclear weapons, but 60% oppose US involvement in the war.  I’m glad I don’t have to thread that needle!

Obviously, there are market implications if the US does get involved but given the complete lack of clarity on the situation at this point, I do not believe I can add much to the discussion.  The only thing I will say is that the longer-term trends for both oil (lower) and metals (higher) are still intact, but we are likely to see some significant volatility along the way.

Which takes us to the next most important market discussion, the FOMC meeting that ends today and the potential market impacts.  It is universally assumed that there will be no policy change at the meeting, either interest rates or QT, which means that now the punditry is focused on the arcana of Fed policy.  As this is a quarter end meeting, the Fed will release its latest SEP (summary of economic projections) and dot plot, and with nothing else to discuss until the war in Iran either ends or intensifies, those are the key discussion points in the market.  

I have long maintained that one of the greatest blunders of the Bernanke era was the institution of forward guidance.  While it may have served its purpose initially, it has now become a major distraction.  Far too much attention is paid to the dot plot, where if one member adjusts their view by 25bps, it can impact markets which have built algorithms to respond to the median outcome.

Below is the March dot plot which showed a median “expectation” of Fed funds for the end of 2025 at 3.875%, or 50 basis points lower than the current level.  However, if two more FOMC members (out of 17) thought there was only going to be one cut, that would have shifted the median “expectation” as well as the narrative.

As such, the importance of the dot plot feels overstated compared to its actual value.  After all, no FOMC member has an impressive track record with respect to their analysis of the economy and its future outcomes, let alone what the appropriate rate structure should be at any given time.  In fact, nobody has that, which is the argument for restricting the Fed’s duties to be lender of last resort and allow markets to determine the proper level of interest rates based on the supply and demand of money.  But this is the world in which we live.  My one observation is that the post GFC era has greatly distorted views on the economy and appropriate monetary policy.  It is hard not to look at the below history of Fed funds and see the anomaly that occurred during the initial QE phase.  

Concluding, regardless of my, or anyone not on the FOMC’s, views on appropriate policy, it doesn’t matter one whit.  They are going to do what they deem appropriate, and while I don’t doubt their sincerity, I do doubt they have the tools for the mission.  Perhaps the most interesting thing that could come from this meeting is further information on their assessment of the current Fed process, including their communication policy.  I remain strongly in favor of them all shutting up and letting markets do their job although that seems unlikely.  But perhaps they will get rid of the dots which seem to have outlived any value they may have had initially.

Before we go to markets, I have to highlight one other market discussion this morning with Bloomberg publishing two different articles, here and here,  on the end of the dollar’s hegemony.  The first highlights a speech by PBOC governor Pan Gongsheng and his vision of a multicurrency world which, of course, includes the renminbi as a major part of the process.  I will believe that is a possibility as soon as China opens its capital accounts completely and allows flows into and out of the country with no restrictions.  (I’m not holding my breath.)  The second takes the Michael Bloomberg Trump hatred in the direction of the president is destroying the dollar’s reign because of his policies and to highlight the dollar has fallen 10% already this year!  But let us look at a long-term chart of the dollar, using the DXY as a proxy, and you tell me if you can see the recent move as being outsized in any sense of the word.  In fact, the dollar’s recent price action is indistinguishable from anywhere in its history, and it is not anywhere near to its historic lows.  In fact, it is just a few percent below its long-term average.

Ok, now let’s look at markets.  Yesterday’s selloff in equities seemed to be based on concerns over the escalation in Iran, but as that drags out, traders don’t know what to do.  They are certainly not pushing things much further.  In fact, overnight saw the Nikkei (+0.9%) have a solid gain although HK (-1.1%) followed the US lower.  Elsewhere in the region, South Korea and Taiwan performed well, while India and Indonesia lagged and the rest were +/-20bps or less.  Europe, though, is softer this morning with declines on the order of -0.4% on the continent across the board.  I think investors here are also waiting on the potential events in Iran.  But US futures are actually pointing slightly higher at this hour (7:30).

In the bond market, yields around the world are slipping with Treasuries falling -2bps and most of Europe seeing declines between -1bp and -3bps.  This is after a few basis point decline yesterday as well.  I guess the fear of too much US debt is in abeyance this morning.

In commodity markets, oil, which rallied sharply yesterday on fears of the US entering the war, is little changed on the day after that climb as while there has been lots of talk, oil continues to flow through the Strait of Hormuz, and everybody is pumping nonstop to take advantage of the current relatively high prices.  Gold is unchanged although the other metals (Ag +0.25%, Cu +0.7%, Pt +2.4%) continue to see significant support.  In fact, platinum this morning has broken above the top of an 11-year range and many now see an opportunity for a significant rally from here.

Finally, the dollar is somewhat softer this morning, slipping about 0.2% against the pound, euro and yen, with similar declines against most other currencies.  The exceptions to this are the KRW (+0.45%) which seems to be benefitting from a growing hope that a trade deal will be completed between the US and Korea shortly, and ZAR (-0.5%) as CPI data release there this morning shows inflation under control and no reason for SARB to consider tightening policy further.

On the data front, because of tomorrow’s Juneteenth holiday, we see Initial (exp 245K) and Continuing (1940K) Claims as well as Housing Starts (1.36M) and Building Permits (1.43M).  And of course, at 2:00 it’s the Fed.  My sense is absent a US escalation in Iran, it will be quiet until the Fed, and probably thereafter as well given the lack of reason for any policy changes.  After all, there is no certainty as to either war or trade policy right now, so why would they do anything.

If I had to opine, I would say the dollar is likely to decline over the next year, but that in the longer run, it will be firmer than today.  

Good luck

Adf

No Retreating

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The virtue of patience remains
The key to our policy gains
Though tariffs and trade
May one day, soon, fade
It’s still ‘nuff to scramble our brains

 

In a bit of a surprise, Chairman Powell resurrected the term ‘transitory’ in his press conference yesterday with respect to the potential impact on prices from President Trump’s tariff policies.  He explained, “We now have inflation coming in from an exogenous source, but the underlying inflationary picture before that was basically 2½% inflation, 2% growth and 4% unemployment.”  In addition, he said, “It’s still the truth if there’s an inflationary impulse that’s going to go away on its own, it’s not the right policy to tighten policy because by the time you have your effect, you’re in effect, by design, you are lowering economic activity and employment.”  It is this mindset that returned ‘transitory’ to the discussion.  Now, while mainstream economics would agree to that characterization, with the idea being it is a one-off price rise, not the beginning of a trend, given the Fed’s history of using the word to describe the impact of monetary and fiscal policies in the wake of the pandemic, it caught most observers off guard.

But in the end, the Fed’s only policy change was a reduction in the pace of runoff of Treasuries from the Balance Sheet on a temporary basis.  Previously, they had been allowing $25B per month to run off without being replaced and starting April 1, that will be reduced to $5B per month.  The runoff of Mortgage-backed assets will continue as before.  This has been a widely discussed idea as the Fed approaches their target of “ample” reserves on the balance sheet, an amount they still characterize as “abundant”.

As to changes in the dot plot and SEP forecasts, they were, at the margin, modest, with the median dot plot ‘forecast’ continuing to call for 2 rate cuts this year.  Fed fund futures are now pricing in 65bps of cuts, so marginally tighter than the 75bps seen last week.  The SEP also showed slightly different forecasts for growth, inflation and unemployment, but just a tick or two different, hardly enough about which to get excited.  

Certainly, Mr Powell said nothing to upset equity markets as the response was a continuation of the modest rally that began in the morning.  As well, bond yields slid almost 9bps from their level just before the Statement was released.  Net, I expect the only people who are unhappy with the Fed’s performance are the hundreds of millions of Americans who have seen the inflation rate remain above the 2.0% target for the past 48 months (see chart below), but then Powell doesn’t really respond to them directly, now does he?

Source: tradingeconomics.com

Oh yeah, President Trump also published a little note on Truth Social that Powell should cut rates, but I don’t think that had any impact at all.  For now, Trump’s attention is elsewhere, and if 10-year yields continue to slide, I suspect he will be fine, certainly Secretary Bessent will be.

In Europe, the leaders are meeting
Again, as they keep on repeating
They need to spend more
To maintain the war
In Ukraine, ‘cause there’s no retreating

Back in the real world, the diverging points of view between President Trump, and his attempts to end the Ukraine War, and the EU, which seems hell-bent on continuing it ad infinitum were highlighted again today as yet another summit meeting is being held in Brussels to discuss the process and progress on rearming the continent as well as how they envision the future of Ukraine.  This matters to markets as the continuous calls for more fiscal military spending is going to be a driver of equity prices in Europe, and given it is going to be funded by issuing more debt, on both a national and supranational basis, yields are likely to rise as well over time.  

There has been much talk lately of the end of US exceptionalism, and certainly there has been a shift of investment into European shares, especially defense firms, and out of US tech shares.  This has helped support the single currency, which while it has slipped the past two days, remains higher by 4.5% since the beginning of the month.  Ex ante, there is no way to know how this situation will evolve, but if history is a guide at all, the US continues to hold all the defense cards in the deck, and so even with European protests, I suspect the war will come to an end.

But here’s a thought, perhaps even if the war ends, the pre-war energy flows may not resume.  This would not be because Europe doesn’t want cheap Russian gas, but perhaps because Russia doesn’t want to sell it to those who will use it to build armaments that can be used against Russia.  The world has moved to a different place both politically and economically, than where it was pre-Covid.  My sense is many old models may no longer work as proxies for reality, which takes me back to my favorite theme, the one thing on which we can count is more volatility!

Ok, let’s take a turn through markets overnight.  After the US rally, Asia was far more mixed with the Nikkei (-0.25%) slipping a bit and both China (-0.9%) and Hong Kong (-2.2%) falling more substantially on fears that US tariffs could slow growth there more than previously feared.  But elsewhere in the region there were far more gains (Korea, Australia, India, Taiwan) than losses (Malaysia, Thailand). 

Europe, though, is having a tougher session with losses across the board.  The continent is particularly hard hit (Germany -1.7%, France -1.2%, Spain -1.2%) although the UK (-0.3%) is holding up better after decent employment data was released.  We did see the Swiss National Bank cut its base rate by 25bps, as expected, while Sweden’s Riksbank left rates on hold, also as expected.  In fairness, European stocks have had quite a good run, so a pullback should not be a surprise, but it is disappointing, nonetheless.  As to US futures, at this hour (7:10), they are pointing lower by -0.5% or so.

In the bond market, Treasury yields are lower by a further -4bps this morning and down to 4.20%, still well within the recent trading range (see chart below).  As to European sovereigns, they too are lower by between -3bps and -5bps, as despite concerns over potential new issuance, fear seems to be today’s theme.  Oh yeah, JGB yields are still pegged at 1.50%.

Source: tradingeconomics.com

In the commodity bloc, oil is little changed this morning, and net, on the week little changed as well.  It is difficult to see short-term drivers although I continue to believe we will see it drift lower over time as supply continues apace while demand, especially in a slowing growth scenario, is likely to ebb.  Gold (-0.6%) is having its worst day in more than a week, but the trend remains strongly higher.  Arguably a bit of profit taking is visible today.  This is dragging silver (-1.8%) along for the ride although copper (+0.1%) is sitting this move out.

Finally, the dollar is firmer again this morning, higher by 0.5% according to the DXY, with the biggest currency laggards the AUD (-1.1%), SEK (-0.8%) and ZAR (-0.75%).  But the dollar’s strength is universal this morning.  One possibility is that traders have decided Powell is not going to cut rates, hence more pressure on US equities, and more support for the dollar.  I don’t agree with that thesis, as I believe Powell really wants to cut rates, but for now, the other argument has the votes.

On the data front, we get the weekly Initial (exp 224K) and Continuing (1890K) Claims as well as the Philly Fed (8.5) all at 8:30.  Then at 10:00 we see Existing Home Sales (3.95M) and Leading Indicators (-0.2%).  Also, at 8:00 we will get the BOE rate decision, with no change expected.  However, as I have been explaining, central bank stories are just not that important, I believe.  Investors in the UK are far more worried about the Starmer fiscal disaster than the BOE.

There are no Fed speakers on the schedule today, so, I suspect it will be headline bingo.  While the dollar has outperformed for the past two sessions, I continue to believe the trend is lower for the buck and higher for commodities.  Perhaps today is a good day to take advantage of some dollar strength for payables hedgers.

Good luck

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Positioned Quite Well

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The Fed is positioned quite well
To leave rates alone for a spell
Employment is stable
Which means they are able
To try, high inflation, to quell

 

“In discussing the outlook for monetary policy, participants observed that the Committee was well positioned to take time to assess the evolving outlook for economic activity, the labor market, and inflation, with the vast majority pointing to a still-restrictive policy stance. Participants indicated that, provided the economy remained near maximum employment, they would want to see further progress on inflation before making additional adjustments to the target range for the federal funds rate.”

I would say that this paragraph effectively summarizes the Fed’s views during the January FOMC meeting and based on the comments we have heard since, nothing has really changed much.  If anything, there appeared to be more concern over the upside risks to inflation than worries over a much weaker employment picture.  As well, there was some discussion regarding the potential of tariffs impacting prices and economic activity, although they would never be so crass as to actually use the word.

I would argue we don’t know anything more about their views now than we did prior to the Minutes.  Interestingly, they continue to believe that the current policy rate is restrictive even though Unemployment has been sliding, inflation is sticky on the high side and equity and other financial markets continue to make record highs.  Personally, I would have thought the appropriate view would be policy is slightly easy, but then I’m no PhD economist, just a poet.  If we learned anything it is that they are not about to change the way they view the world.  This merely tells me they have the opportunity to double down on previous mistakes.

It’s almost as if
Japanese markets now see
Future yen glory

Meanwhile, away from the machinations and procrastinations of the Fed, if we turn East, we can see that last night the yen, for a brief moment, traded through the key 150 psychological level, although it has since edged back higher.  This is the strongest the yen has been in more than two months and, in a way, is somewhat surprising given the strong belief that tariffs imposed against a nation will result in that nation’s currency declining.  But that is not the case right now, where despite mooted tariffs on steel, autos and semiconductors, three things the Japanese export to the US, the yen is climbing again.  

Source: tradingeconomics.com

One of the interesting things about the interest rate market’s response to the FOMC Minutes is that there continues to be an expectation of 39bps of rate cuts this year in the US.  But then, I read the Minutes as somewhat hawkish, obviously a misconception right now.  Meanwhile, in Tokyo, we continue to hear comments from former BOJ members that further rate hikes are coming and the futures market there is pricing 36bps of rate hikes by the end of this year.  So, for now, the direction of travel is diametrically opposed between the Fed and the BOJ.  Last night also saw JGB yields edge higher by another 1bp, to 1.43% and another new high level for this move.  Add it all up and the rate movements are sufficient to be the current FX drivers.

Now, as per my opening discussion regarding the Fed, while I believe that the next move should be a hike, and that gained support from a WSJ article this morning telling us to expect higher rent prices ahead which implies that the shelter portion of US inflation is not going to decline anytime soon, perhaps this is another reason to consider that the dollar may decline.  After all, the textbooks all explain that a high inflation economy results in a weaker currency.  If the Fed is truly going to continue to try to ‘normalize’ rates lower despite rising inflation, that will change my broad view of the dollar, and I suspect it will weaken dramatically.  While the yen is the first place to watch this given the opposing actions by the Fed and BOJ, it could easily spread.

Too, it is important to remember that while we have lately become accustomed to the yen trading in the 140-160 range vs. the dollar, for many years USDJPY traded between 100 and 120 as per the below chart.  While the world has certainly changed, it doesn’t mean that we cannot head back to those levels and spend another decade at 110 give or take a bit.

Source: tradingeconomics.com

Ok, with that in mind, let’s take a look at how markets have handled the new information.  Clearly US equity markets are not concerned about a Fed volte-face as they closed at yet new record highs yesterday, albeit with very modest gains of about 0.2%.  Asian markets, however, were not so sanguine with red the dominant color as the Nikkei (-1.25%) suffered amid that strengthening yen while both the Hang Seng (-1.6%) and mainland (CSI 300 -0.3%) fell despite PBOC promises of more support for the economy and the property market.  If I’m not mistaken, this is the third time the PBOC has said they will be increasing support for property markets and prices there continue to decline.  In fact, every major index in Asia fell overnight, mostly impacted by tariff fears.

Meanwhile, European bourses are all modestly firmer save the UK (-0.4%) as we see a rebound after yesterday’s declines and earnings data from Europe continues to show decent outcomes.  While there is much talk and angst over the Ukraine situation and tariffs, right now given the uncertainty of the timing of any tariffs, as well as the possibility that they may be delayed further or deals may be struck, investors seem to be laying low.  Remember, though, that European equity markets have been outperforming US markets for the past several months, although that could well be because their valuations had become so cheap, we are seeing a rotation into them for now.  As to the US markets, futures are pointing slightly lower at this hour (7:15) down about -0.25%.

In the bond market, yesterday saw Treasury yields cede their early gains and slip 2bps on the session and this morning they have fallen a further 2bps.  Meanwhile, European sovereign yields, after jumping yesterday across the board, are falling back slightly with declines on the order of -1bp or -2bps.

In the commodity market, the one constant is that the price of gold (+0.4%) continues to climb.  Whether it is because of growing global uncertainty, concerns over rising inflation, or technical questions regarding deliveries in NY, it is not clear.  Price action is not volatile, rather it has been a steady climb for more than a year.  just look at the chart below.

Source: tradingeconomics.com

As to the other metals, both silver and copper are also continuing their climb and higher by 1.0% this morning.  Oil (+0.2%) is also edging higher which seems a bit odd given the fundamental news I keep reading.  First, OPEC+ is going to begin increasing production later this year, second, the prospects of a peace deal with Russia seems likely to result in Russian oil coming back on the market sans sanctions, and third, despite talk of Chinese economic stimulus, demand from the Middle Kingdom has not been growing.  Add to this the fact that supply is expected to grow by upwards of 1mm bpd from Guyana, Brazil and Canada, and it seems a recipe for falling prices.  Just goes to show that markets are perverse.

Finally, the dollar is under pressure across the board this morning with the yen (+0.95%) leading the way but commodity currencies (AUD +0.5%, NZD +0.5%, ZAR +0.4%) also showing strength.  In fact, virtually every currency has strengthened vs. the greenback this morning.  Looking at the charts, there is a strong similarity across almost all currencies vs. the dollar and that is the dollar put in a peak back in early January and has been gradually declining since then.  This is true across disparate currencies as seen below and may well represent the market deciding that President Trump would like to see the dollar decline and will enact policies to achieve that end.  (I used USDDKK as a proxy for EURUSD since the two are linked quite closely with a correlation of about 0.99.)

Source: tradingeconomics.com 

As I wrote above, my strong dollar thesis is based on the Fed continuing to fight inflation.  If they abandon that fight, then the dollar will certainly decline!

On the data front, this morning brings Initial (exp 215K) and Continuing (1870K) Claims as well as the Philly Fed (20.0).  In addition to the Minutes yesterday we saw Housing Starts tumble although Permits were solid.  However, there is clearly some concern over the housing market writ large, with fewer first-time buyers able to afford a new home, hence the rent story above.  We have 3 more Fed speakers today but again, I ask, are they going to change their tune?  I don’t think so.  I find it hard to believe that the Fed will allow inflation to rebound sharply, but if they remain focused on rate cuts while inflation continues to creep higher, I fear that will be the outcome.  And that, as I said above, will be a large dollar negative.  We shall see.

Good luck

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Shattered His Dreams

Posted on by

The data was hot yesterday
And that put the pressure on Jay
It shattered his dreams
‘Bout all of his schemes
To help keep inflation at bay

 

By now, I am sure you are aware that the CPI data was higher than forecast, and certainly higher than would have made Chairman Powell comfortable.  The outcome, showing Headline rising to 3.0% and core rising to 3.3% with correspondingly higher monthly rises was sufficient to alter the narrative at least a little bit.  Chair Powell even mentioned it in his House testimony, noting, “We are close, but not there on inflation…. So, we want to keep policy restrictive for now.”  Essentially, the data makes clear that the Fed is not going to be cutting the Fed funds rate anytime soon.  The futures market got the message as it is now pricing just 29bps of cuts this year, with December the likely date.

It will be no surprise that the stock market’s initial response was to sell off substantially, but as per the chart below, it spent the rest of the day clawing back the losses and wound up little changed on the day.  This morning, it remains basically unchanged as well.

Source: tradingeconomics.com

Treasury bonds, though, had a less fruitful session, falling (yields rising) sharply on the print, but never really regaining their footing with yields jumping almost 15bps at one point although finishing the day about 10bps higher and have given back 2bps more this morning.

Source: tradingeconomics.com

Now, we all know that the Fed doesn’t target CPI, but rather PCE.  However, after this morning’s PPI data release, most economists (although not poets) will be able to reasonably accurately estimate that data point for later this month, as will the Fed.  And that number is not going to be moving closer to their 2.0% target.  What seems very clear at this point is that every Fed speaker for the time being is going to be harping on the caution with which they are going to move forward.

If we look at this from a political perspective, something which is unavoidable these days, it is important to remember that Treasury Secretary Bessent has made clear that he and the president are far more focused on the 10-year yield than on the Fed funds rate.  To that end and given the fact that all this data was from a time preceding President Trump’s inauguration, I don’t think they are too worried.  I would look for the President to continue his drive to reduce waste and fraud in the government and attack that deficit.  Certainly, the news to date is there is a great deal of both waste and fraud to reduce, and if the president is successful, I believe that will play out in significantly lower 10-year yields, if for no other reason than the deficit is reduced or closed.  This story is just beginning to be written.

Now, Putin and Trump had a call
As Trump tries to end Russia’s brawl
They’re slated to meet
So, they can complete
A treaty with Europe awol

Under any interpretation, I believe the news that Presidents Trump and Putin are going to meet in an effort to hammer out an end to the Russia/Ukraine war is good news.  Beyond the simple fact that less war is an unadulterated good, I think it is very clear that this particular war has had significant market impacts, hence our interest here.  Obviously, energy prices have been impacted, as both oil and NatGas prices are higher than they would otherwise be given the removal of some portion of Russia’s exports from the global markets and economy.  As such, the end of this conflict, with one likely consequence being Western Europe reopening themselves to Russian energy imports, is likely to see prices decline.  

This matters for more reasons than the fact it will be cheaper to fill up your tank at the gas (petrol) station, it is very likely to have a very positive impact on inflation writ large.  As you can see from the chart below, there is a very strong correlation between the price of oil and US inflation expectations.  Declining oil prices are very likely to help people perceive a less inflationary future and will reduce the rate of inflation by definition.  

Source: ISABELNET

Inflation is an insidious process, and once entrenched is very hard to reduce, just ask Chairman Powell.  I also know that there has been much scoffing at President Trump’s claims he will reduce inflation, especially with his imposition of tariffs all over the place. (It is important to understand that tariffs are not necessarily inflationary by themselves as well explained by my friend the Inflation guy in this article.). However, between his strong start on reducing government expenditures and the potential for an end to the Russia/Ukraine war leading to lower energy prices, these are longer term effects that may do just that.

Ok, let’s move on to the market activities in the wake of yesterday’s CPI and ahead of this morning’s PPI data.  As discussed above, yesterday’s US markets rebounded from their worst levels of the morning and closed modestly lower with the NASDAQ actually unchanged.  In Asia, Japanese shares (+1.3%) had a solid day as the weak yen helped things along although Chinese shares (HK -0.2%, CSI 300 -0.4%) did not fare as well on the day with tariffs still top of mind.  Elsewhere in the region, other than Korea (+1.4%) movement was mixed and modest.  In Europe, the possibility of peace breaking out in Ukraine has clearly got investors excited as both Germany (+1.5%) and France (+1.2%) are seeing strong inflows. The UK (-0.7%) however, continues to suffer from economic underperformance with no discernible benefits shown from the governments weak efforts to right the ship.  GDP was released this morning and while they avoided recession, it’s very hard to get excited over 0.1% Q/Q growth.  As to the US futures market, at this hour (7:20), they are essentially unchanged.

In the bond market, we’ve already discussed Treasury yields, but another benefit of the prospects for a Ukrainian peace is that sovereign yields have fallen substantially, between -5bps and -8bps, throughout the continent.  Once again, the impact of that phone call between Trump and Putin has been quite significant.  Consider that not only are energy prices likely to slide, but the required government spending to prosecute the war is likely to diminish as well.

In the commodity markets, it should be no surprise that oil (-1.3%) prices are sliding as are NatGas prices in Europe (TTF -7.5%) as the opportunity for cheap Russian gas to flow to Europe is once again in view.  To highlight the impact that this has had on Europe, prior to the Ukraine war and the halting of gas flows, the TTF contract hovered between €5 and €25 per MWh.  Since the war broke out, even after the initial shock, it has been between €25 and €55 per MWh.  This is all you need to know about why Europe, and Germany especially, is deindustrializing.  As to the metals markets, after a few days of consolidation, gold (+0.4%) is on the move again although it has not yet recaptured the highs seen early Tuesday morning.  Give it time.  Copper (+0.6%), too, is back on the move and indicating that economic activity is set to continue to grow.

Finally, the dollar is mixed this morning, although arguably a touch softer overall, as the Russia news has traders looking for less negativity in Europe.  So modest gains in the euro and pound, about 0.15% each is offsetting larger losses in AUD (-0.3%) and NZD (-0.6%), although given the much smaller market size of the latter two, they matter much less.  JPY (+0.4%) is rebounding after yesterday’s sharp decline on the back of the jump in Treasury yields, and it is noteworthy that CHF (+0.65%) is gaining after its CPI data showed a decline in prices last month.  In the EMG bloc, CLP (+0.7%) is stronger on that copper rally, while ZAR (+0.1%) seems to be edging higher as gold continues to perform well. MXN (-0.4%) though is still struggling with the potential negative impact of tariffs and otherwise, there is not much to report.

This morning brings PPI (exp 0.3%. 3.3% Y/Y headline; 0.3%, 3.5% Y/Y core) as well as the weekly Initial (215K) and Continuing (1880K) Claims data.  There are no Fed speakers on the docket, but at this point, I expect the Fed will be fading into the background since they are clearly on hold and President Trump commands the spotlight.  Unless the data starts to veer dramatically away from what we have seen, it appears that the market is going to continue to respond to Trumpian headlines, which of course are impossible to predict.  But remember, most of the rest of the world is still in cutting mode so the dollar should continue to hold its own.

Good luck

Adf

Not in a Rush

Posted on by

Said Powell, we’re not in a rush
To cut rates as we try to crush
Remaining inflation
And feel the sensation
Of drawing an inside straight flush
 
Up next is the CPI data
Though not one on which we fixate-a
The surveys explain
That people remain
Quite certain that we’re doing great-a

 

Chairman Powell testified to the Senate Banking Committee yesterday and the key comments were as follows, “Inflation has eased significantly over the past two years but remains somewhat elevated relative to our 2 percent longer-run goal. Total personal consumption expenditures (PCE) prices rose 2.6 percent over the 12 months ending in December, and, excluding the volatile food and energy categories, core PCE prices rose 2.8 percent. Longer-term inflation expectations appear to remain well anchored, as reflected in a broad range of surveys of households, businesses, and forecasters, as well as measures from financial markets.” [Emphasis added.] He followed up, “With our policy stance now significantly less restrictive than it had been and the economy remaining strong, we do not need to be in a hurry to adjust our policy stance.  We know that reducing policy restraint too fast or too much could hinder progress on inflation.”  This is largely what was expected as virtually every Fed speaker since the last FOMC meeting has said the same thing, there is no rush to further cut rates. Powell did admit that the neutral rate had risen compared to where it was before inflation took off in 2022 but maintains that current policy is still restrictive. 

However, let’s examine the highlighted comment above a little more closely.  Two things belie that statement as wishful thinking rather than an accurate representation of the current situation.  The first is that the most recent survey released from Friday’s Michigan Sentiment surveys, shows that inflation expectations for the next year jumped dramatically, one full percent to 4.3% as per the below chart.

Source: tradingeconomics.com

Looking over the past 10 years of data, that is a pretty disturbing spike, taking us right back to the 2022-23 period when inflation was roaring.  In addition to that little jump, it is worth looking at those market measures that Powell frequently mentions.  Typically, they are either the 5-year or 10-year breakeven rate.  That rate is the difference between the 5-year Treasury yield and the 5-year TIPS yield (or correspondingly the 10-year yields).  A quick look at the chart below shows that since the Fed first cut rates in September 2024, the 5-year breakeven rate has risen 78bps to 2.64%.  Certainly, looking at the chart, the idea of ‘well anchored’ isn’t the first description I would apply.  Perhaps, rocketing higher?

At any rate, it appears quite clear that the Fed is on hold for a while yet as they await both the evolution of the economy and further clarity on President Trump’s policies on tariffs.  While there is no doubt that we will continue to hear from various Fed speakers going forward, I maintain that the Fed is not seen as the primary driver in markets right now, rather that is President Trump.

Of course, data will still play a role, just a lesser one I believe, but we cannot ignore the CPI report due this morning.  First, remember, the Fed doesn’t focus on CPI, but rather on PCE which is typically released at the end of the month and calculated by the Commerce Department, not the BLS.  But the rest of us basically live in CPI land, so we all care.  If nothing else, it gives us something to complain about as we look incredulously at the declining numbers despite what we see with our own eyes every time we go shopping.

As it is, here are this morning’s median expectations for the data, headline CPI (+0.3% M/M, 2.9% Y/Y) and core CPI (+0.3% M/M, 3.1% Y/Y).  Once again, I believe there is value in taking a longer view of this data for two reasons; first to show that we are not remotely approaching the levels to which we became accustomed prior to the Covid pandemic and government response, and second to highlight that if your null hypothesis is CPI continues to decline, that may not be an appropriate view as we have spent the past 8 months in largely the same place as per the below chart.  Too, note the similarity between the Michigan Survey chart above and this one.

Source: tradingeconomics.com

OK, those are really the stories of the day since there have not, yet, been any new tariffs imposed by President Trump, and traders need to focus on something.  Let’s take a look at how things behaved overnight.

After a mixed US equity session, the strength was in Hong Kong (+2.6%) and China (+1.0%), seemingly on the back of several stories.  First is that China is looking at new ways to address the property bubble’s implosion, potentially allocating more support there, as well as this being a reflexive bounce from yesterday’s decline and the story that President’s Xi and Trump have spoken with the hope that things will not get out of hand there.  As to Japan, the Nikkei (+0.4%) has edged higher as the yen (-0.7%), despite a lot of talk about higher rates in Japan and the currency being massively undervalued, continues to weaken.  In Europe, once again there is limited movement overall with very tiny gains of less than 0.2% the norm although Spain’s IBEX (+0.7%) is the big winner today on some positive earnings results.  US futures are little changed at this hour (7:15).

In the bond market, Treasury yields are unchanged this morning, retaining the 4bps they added yesterday, and in Europe, sovereign yields are also little changed with German Bunds (+2bps) the biggest mover in the session.  JGB yields did rise 3bps overnight, but that seems to be following US yields as there was precious little new news there.

In the commodity markets, yesterday’s metal market declines are mostly continuing this morning with gold (-0.6%) down again, although still hanging around $2900/oz.  Silver has slipped although copper (+0.3%) has arrested its decline.  Oil (-1.1%) is giving back some of yesterday’s gains and continues to trade in the middle of its trading range with no real direction.  One thing I haven’t highlighted lately is European TTF NatGas prices, which while softer this morning (-1.9%) have risen 15% in the past month as storage levels in Europe are declining to concerning levels and global warming has not resulted in enough warm days for the winter.

Finally, the dollar is mixed away from the yen’s sharp decline with the euro (+0.1%) and CHF (+0.2%) offsetting the AUD (-0.3%) and NOK (-0.5%).  It is interesting that many of the financial and trading accounts that I follow on X (nee Twitter) continue to point to JPY and CAD as critical and are anticipating strength in both those currencies imminently.  And yet, neither one is showing much tendency to strengthen, at least for the past month or two.  I guess we shall see, but if the Fed is going to remain on hold, and especially if more tariffs are coming, I suspect the default direction of the dollar will be higher.  As to the EMG bloc, there is virtually nothing happening here, with a mix of gainers and laggards, none of which have moved 0.2% in either direction.

Other than the CPI data, Chairman Powell testifies to the House Financial Services Committee, and we will see EIA oil inventories with a modest build anticipated.  We also hear from two other Fed speakers, but again, with Powell in the spotlight, they just don’t matter.

Markets overall are pretty quiet, seemingly waiting for the next shoe to drop.  My money is on that shoe coming from the Oval Office, not data or Powell, which means we have no idea what will happen.  Stay hedged, but until further notice, I still don’t see a strong case for the dollar to decline.

Good luck

Adf

Loathing and Fear

Posted on by

On Friday, the jobs situation
Explained there was little causation
For loathing or fear
That later this year
Recession would soon drive deflation
 
Meanwhile, in the Super Bowl’s wake
The president’s set to forsake
Economists’ warning
That tariffs are scorning
Their views, and are quite a mistake

 

Let’s start with a brief recap of Friday’s employment report which was surprising on several outcomes.  While the headline was a touch softer than forecast, at 143K, revisions higher to the prior two months of >100K assuaged concerns and implied that the job market was still doing well.  You may recall that there were rumors of a much higher Unemployment Rate coming because of the annual BLS revisions regarding total jobs and population, but in fact, Unemployment fell to 4.0% despite an increase in the employed population of >2 million.  Generally, that must be seen as good news all around, even for the Fed because the fact that they have paused their rate cutting cycle doesn’t seem to be having any negative impacts.

Alas for Powell and friends, although a real positive for the rest of us, the Earnings data was much stronger than expected, up 0.5% on the month taking the annual result to a 4.1% increase.  Recall, one of Powell’s key concerns is non-core services inflation, and that is where wages have a big impact.  After this data, it becomes much harder to anticipate much in the way of rate cuts soon by the Fed.  This was made clear by the Fed funds futures market which is now pricing only an 8.5% probability of a rate cut in March, down from 14% prior to the data, and only 36bps of cuts all year, which is down about 12bps from before.

Securities markets didn’t love the data with both stocks and bonds declining in price, although commodities markets continue to rally alongside the dollar, a somewhat unusual outcome, but one that makes sense if you consider the issues.  Inflation is not yet dead, hurting bonds, while the fact the Fed is likely to remain on hold for longer supports the dollar.  Stocks, meanwhile, need to see more economic growth because lower rates won’t support them while commodities are seen as that inflation fighting haven.

Of course, it wouldn’t be a day ending in Y if we didn’t have another discussion on tariffs during this administration.  The word is that the president has two things in mind, first, reciprocal tariffs, meaning the US will simply match the tariff levels of other countries rather than maintaining their current, generally lower, tariff rates.  As an example, I believe the EU imposes a 10% tariff on US automobile imports, while the US only imposes a 2.5% tariff on European imports.  The latter will now rise to 10%.  It will be very interesting to see how the Europeans complain over the US enacting tariffs that are identical to their own.  

A side story that I recall from a G-20 meeting during Trump’s first term was that he offered to cut tariffs to 0% for France if they reciprocated and President Macron refused.  The point is that while there is a great deal of huffing and puffing about free trade and that Trump is wrecking the world’s trading relationships, the reality appears far different.  If I had to summarize most of the world’s view on trade it is, the US should never put tariffs on any other country so they can sell with reckless abandon, while the rest of the world can put any tariffs they want on US stuff to protect their home industries.  This is not to say tariffs are necessarily good or bad, just that perspective matters.

The other Trump tariffs to be announced are on steel and aluminum imports amounting to 25% of the value. This will be impactful for all manufacturing industries in the US, at least initially, so we will see how things progress.  Interestingly, the dollar has not responded much here because these are not country specific, so a broad rise in the dollar may not be an effective mitigant.

Ultimately, as I have been writing for a while, volatility is the one true change in things now compared to the previous administration.  Now, with that as backdrop, and as we look ahead to not only CPI data on Wednesday, but Chair Powell’s semi-annual congressional testimony on Tuesday at the Senate and Wednesday at the House, let’s look at how markets have responded to things.

As mentioned above, US equity markets fell about -1.0% on Friday after digesting the Unemployment data. However, the picture elsewhere, especially after these tariff discussions, was more mixed.  In Asia, Japanese shares were essentially unchanged although Hong Kong (+1.8%) was the big winner in the region.  But Chinese shares (+0.2%) did little, especially after news that the number of marriages in China fell to their lowest since at least 1986, another sign of the demographic decline in the nation.  Elsewhere in the region, there was more red (India, Taiwan, Australia) than green (Singapore).  European shares, though, are holding up well, with modest gains of about 0.2% – 0.4% across the board despite no real news.  US futures are also ticking higher at this hour (7:10), about 0.5% across the board.

In the bond market, Friday saw Treasury yields jump 6bps with smaller gains seen in Europe.  This morning, though, the market is far quieter with Treasury yields unchanged and European sovereigns similarly situated, with prices between -1bp and +1bp compared to Friday’s closing levels.  Of note, JGB yields have edged higher by 1bp and now sit at 1.31%, their highest level since April 2010.  With that in mind, though, perhaps a little bit of longer-term perspective is in order.  A look at the chart below shows 10-year JGB yields and USDJPY since 1970.  Two things to note are that they have largely moved in sync and that both spent many years above their current levels.  While it has been 15 years since JGB yields were this high, they are still remarkably low, even compared to their own history.  I know that many things have changed over that time driving fundamentals, but nonetheless, this cannot be ignored.

Source: tradingeconomics.com

Sticking with the dollar, it has begun to edge higher since I started writing this morning and sits about 0.2% stronger than Friday’s close.  USDJPY (+0.5%) is once again the leader in the G10, although weakness is widespread in that bloc.  In the EMG bloc, there were a few gainers overnight (INR +0.3%, KRW +0.3%) although the rest of the world is mostly struggling.  One interesting note is ZAR (0.0%) which appears to be caught between the massive rally in gold (to be discussed below) and the increased rhetoric about sanctions by the US in the wake of the ruling party’s ostensible call for a genocide of white South Africans to take over their property.  This has not been getting much mainstream media press, but it is clear that Mr Trump is aware, especially given that Elon Musk is South African by birth.  However, there is no confusion in the South African government bond market, which, as you can see below, has seen yields explode higher in the past week since this story started getting any press at all.

Source: tradingeconomics.com

Finally, the commodity markets continue to show significant movement, especially the metals markets.  Gold (+1.6%) is now over $2900/oz, another new all-time high and calling into question if this is just an arbitrage between London and New York deliveries.  Silver (+1.4%) continues to be along for the ride as is copper (+0.6%) which is the biggest gainer of the past week, up more than 7%.  Ironically, aluminum, the only metal where tariffs are involved, is actually a touch softer this morning.  As to oil (+1.2%) while the recent trend remains lower, it does appear to be bottoming, at least if we look at the chart below.

Source: tradingeconomics.com

Turning to the data this week, it will be quite important as CPI headlines, but we also see Retail Sales and other stuff and have lots of Fedspeak.

TuesdayNFIB Small Biz Optimism104.6
 Powell Testimony to Senate 
WednesdayCPI0.3% (2.9% Y/Y)
 -ex food & energy0.3% (3.1% Y/Y)
 Powell Testimony to House 
ThursdayPPI0.3% (3.4% Y/Y)
 -ex food & energy0.3% (3.3% Y/Y)
 Initial Claims216K
 Continuing Claims1875K
FridayRetail Sales-0.1%
 -ex autos0.3%
 IP0.2%
 Capacity Utilization77.7%

Source: tradingeconmics.com

In addition to Powell, we will hear from five more Fed speakers, although with Powell speaking, I imagine their words will largely be ignored.  Overall, the world continues to try to figure out how to deal with Trump and his dramatic policy changes from the last administration.  One thing to keep in mind is that so far, polls show a large majority of the nation remains in support of his actions so it would be a mistake to think that his policy set is going to be altered.  Net, the market continues to believe this will support the dollar, as will the fact that the Fed seems less and less likely to start cutting rates soon.  Keep that in mind as you consider your hedges going forward.

Good luck

Adf

Positioning’s Fraught

Posted on by

The wonderful thing about Trump
Is traders no longer can pump
A market so high
That it can defy
Reality ere it goes bump
 
Since policies can change so fast
A long-term view just cannot last
So, Fed put or not
Positioning’s fraught
And larger ones won’t be amassed

 

As we await the NFP report this morning, I couldn’t help but ponder the uptick in complaints and concerns by traders that increased volatility in markets on the back of President Trump’s mercurial announcements has changed the trading game dramatically.  Let me say up front that I think this is a much healthier place to be and explain why.

Pretty much since the GFC and, more importantly, then Chairman Bernanke’s first utilization of QE and forward guidance, the nature of financial markets had evolved into hugely leveraged one-sided views based on whatever the Fed was guiding.  So, the initial idea behind QE and forward guidance was to assure all the traders and investors that make up the market that even though interest rates reached 0.0%, the Fed would continue to ease policy and would do so for as far out in time as you can imagine.  Lower for longer became the mantra and every time there was a hiccup in the market, the Fed rushed in, added yet more liquidity to calm things down, and put the market back on track for further gains.  This was true for both stocks and bonds, despite the fact that the Fed has no business or mandate involving the equity market.

This activity led to the ever-increasing size of trading firms as leverage was cheap and steadily rising securities prices led to lower volatility, both implied and real, in the markets.  Risk managers were comfortable allowing these positions to grow as the calculated risks were minimized by the low vol.  In fact, entire trading strategies were developed to take advantage of the situation with Risk Parity being a favorite.  

However, a negative result of these actions by the Fed was that investors no longer considered the fundamentals or macroeconomics behind an investment, only the Fed’s stance.  The only way to outperform was to take on more leverage than your competitors, and that was great while rates stayed at 0.0%.  Alas, this persisted for so long that many, if not most, traders who learned the business prior to the GFC wound up retiring or leaving the market, and the next generation of traders and investors lived by two credos, number go up and BTFD.

The Fed remained complicit in this process as FOMC members evolved from background players to a constant presence in our daily lives, virtually preening on screens and in front of audiences and reiterating the Fed’s views of what they were going to do, implicitly telling traders that taking large, leveraged bets would be fine because the Fed had their back.

Of course, the pandemic upset that apple cart as the combination of Fed and government response imbued the economy with significantly more inflation than expected and forced the Fed to change their tune.  The market was not prepared for that, hence the outcome in 2022 when both stocks and bonds fell sharply.  But the Fed would not be denied and calmed things down and created a coherent enough message so that markets recovered the past two years.  This has, naturally, led to increased position sizing and more leverage because that’s what this generation of traders understands and has worked.

Enter Donald J Trump as president, elected on a populist manifesto and despite his personal wealth, seemingly focused on Main Street, not Wall Street.  The thing about President Trump is if an idea he proffers doesn’t work, he will drop it in a heartbeat and move on.  As well, by wielding the full power of the United States when dealing in international situations, other nations can quickly find themselves in a difficult spot and, so far, have been willing to bend their knee.  As well, his focus on tariffs as a primary weapon, with little regard for the impact on markets, and the way with which he uses them, threatening to impose them, and holding off at the last minute when other nations alter their policy, has kept markets off-balance.

The result is large leveraged positions are very difficult to hold and manage when markets can move up and down 2% in a day, every day (like the NASDAQ 100 chart below), depending on the headlines.  

Source: tradingeconomics.com

The natural response is to reduce position size and leverage, and that, my friends, is a healthy turn in markets.  This is not to say that there are not still many significant imbalances, just that as they continue to blow up, whether Nvidia, or FX or metals, my take is the next set of positions will be smaller as nimble is more important than large.  It doesn’t matter how smart an algorithm is if there is no liquidity to adjust a position when the world changes.  This poet’s opinion is this is a much healthier place for markets to live.

Ok, let’s see what happened overnight ahead of today’s data.  Mixed is the best description as yesterday’s US closes saw a mixed outcome and overnight the Nikkei (-0.7%) fell while both Hong Kong (+1.2%) and China (+1.3%) gained ground.  Korea and India slid, Taiwan rose, the picture was one of uncertainty about the future.  That also describes Europe, where only Germany and Norway have managed any modest gains at all while the rest of the continent and the UK are all slightly lower.  Apparently, yesterday’s BOE rate cut has not comforted investors in the UK, nor has the talk of more rate cuts by the ECB bolstered attitudes in Europe.  As to US futures, at this hour (7:00) they are basically unchanged.

In the bond market, the biggest mover overnight was in Japan where JGB yields rose 3bps, once again touching that recent 30-year high.  While some BOJ comments indicated inflation remained well-behaved, the market is clearly of the view that Ueda-san is getting set to hike rates further.  In Europe, yields are basically lower by 1bp across the board and Treasury yields are unchanged on the session as investors and traders continue to focus on Treasury Secretary Bessent’s conversation that he cares about 10-year yields, not Fed funds.  Perhaps the Fed will cut rates to recapture the spotlight they have grown to love.

Oil (+0.5%) prices continue to drift lower overall, although this morning they are bouncing from yesterday’s closing levels.  Questions about sanctions policy on Iran, on Russia’s shadow fleet and about the state of the global economy and therefore oil demand remain unanswered.  However, the fact that oil has been sliding tells me that there is some belief that President Trump may get his way regarding a desire for lower oil prices.  In the metals markets, copper (+1.1%) is flying higher again, and seems to be telling us that the economy is in decent shape.  Either that or there is a major supply shortage, although if that is the case, I have not seen any reporting on the subject.  Both gold and silver are very modestly higher this morning after small declines yesterday as the London – NY arbitrage continues to be the hot topic and financing rates for both metals have gone parabolic.

Finally, the dollar is mixed this morning, perhaps slightly firmer as JPY (-0.5%) is actually the worst performer around, despite the rise in JGB yields.  There is a lot of chatter on how the yen is due to trade much higher, and it has rallied over the past month, but it is certainly not a straight line move.  As to the rest of the space, virtually every other currency is +/-0.2% from yesterday’s close with CLP (+0.5%) the lone exception as the Chilean peso benefits from copper’s huge rally.

On the data front, here are the latest expectations for this morning’s employment report:

Nonfarm Payrolls170K
Private Payrolls141K
Manufacturing Payrolls-2K
Unemployment Rate4.1%
Average Hourly Earnings0.3% (3.8% Y/Y)
Average Weekly Hours34.3
Participation Rate62.5%
Michigan Sentiment71.1

Source: tradingeconomics.com

Remember, though, the ADP number on Wednesday was much better than expected at 183K (exp 150K) with a major revision higher by 54K to the previous month).  As well, this month brings the BLS adjustments for 2024 which will not be broken down, just lumped into the data.  Recall, there are rumors of a significant reduction in the number of jobs created in 2024 as well as a significant increase in the population estimates with more complete immigration data, and that has led some pundits to call for a much higher Unemployment Rate.  I have no insight into how those adjustments will play out although the idea they will be large seems highly plausible.

Ahead of the number, nothing will happen.  If the number is strong, so NFP >200K, I expect that bonds will suffer, and the dollar will find some support.  A weak number should bring the opposite, but the revisions are a wild card.  As I stated this morning, the best idea is to maintain the smallest exposures possible for the time being, as volatility is the one thing on which we can count.

Good luck and good weekend

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Is Past Prologue?

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The Japanese tale
Now sees brighter times ahead
Yen buyers rejoice

 

While its movement has been somewhat choppy, for the past month, the yen has been the best performing currency in the G10, gaining more than 3.0% during that time.  This strength seems to have been built on several different themes including a more hawkish BOJ, better growth prospects based on PMI data, rising wages, and some underlying risk aversion.  A quick look at the chart shows that the trend is clearly lower and there have been far more down days for the dollar than up days during this period.

Source: tradingeconomics.com 

Of course, as I regularly remind myself, and you my good readers, perspective is an important thing to keep in mind, especially when making statements about longer term prospects of a currency.  When looking at USDJPY over a longer term, say the past 5 years where long-term trends have been entrenched based on broad macroeconomic issues as well as the day-to-day vagaries of trading, the picture looks quite different.  In fact, as you can see from the below chart, the past month’s movement barely registers.

Source: tradingeconomics.com

My point is that we must be careful regarding the relative importance of information and news and keep in mind that short-term movements may very well be just that, short-term, rather than major changes in long-term trends.  The latter require very significant macro changes regarding interest rate policy and economic activity, at least when it comes to currencies, not simply a single central bank policy move.

So, the question at hand is, are we at the beginning of a major set of policy shifts that will change the long-term trajectory of the yen?  Or is the yen’s recent strength merely normal noise?

While almost everybody has their own opinion on how the Fed is going to proceed going forward, I think it is instructive to look at the Fed funds futures market and the pricing for future rate activity.  For instance, a look at the current market, especially when compared where these probabilities were one month ago tells us that expectations for Fed rate cuts have diminished pretty substantially, arguably implying that there is more reason to hold dollars.

Source: CME.org

You can see in the lower right-hand corner of the chart that the probability of a rate cut has fallen from nearly 44% to just 16.5% over the past month.  However, during that same period, the BOJ has not only raised interest rates by 25bps, but they have made clear that further rate hikes are coming based on wage settlements and sticky inflationary readings.  One potential way to incorporate this relative movement is to look at the change in forecast interest rates, which in the US have risen by ~7bps (27% *25bps) while Japanese interest rates have risen by 25bps with expectations for another 25bps coming soon.  That is a powerful incentive to be long yen or at least less short yen, than previous positioning.  And we have seen that play out as the yen has strengthened as per the above.

The real question is, can we expect this to continue?  Or have we seen the bulk of the movement?   Here, much will depend on the future of the Fed’s actions as the market is seeing a bifurcation between those who believe rates are destined to fall further once inflation starts to ease again, vs. those, like this poet, who believe that inflation is showing no signs of easing, and therefore the Fed will be hard-pressed to justify further rate cuts.  While I am not the last word on the BOJ, from every source I see, expecting their base rate to be raised above 1.00% anytime in the next several years is aggressive.  Just look at the below chart showing the history of the BOJ base rate.  The last time the rate was above 0.50%, its current level, was September 1995.  That is not to say they cannot raise it, just that as you can see, several times in the intervening years they tried to do so and were forced to reverse course as the economy fell back into the doldrums with inflation quickly falling as well.  

Source: tradingeconomics.com

Is past prologue?  Personally, my take is above 1.0% is highly unlikely any time in the next several years.  Meanwhile, if inflation remains the problem it is in the US, Fed cuts will be much harder to justify.  This is not to say that the yen cannot strengthen somewhat further, but I am not of the opinion we have had a sea change in the long-term trend.

Ok, after spending way too much time on the yen, given that there hasn’t even been any tariff discussion on Japanese products, let’s look elsewhere to see how things moved overnight.

Yesterday saw further relief by equity investors that tariffs are a key Trump negotiating tactic rather than an effort to raise revenue and US markets all gained, especially the NASDAQ.  However, the movement in Asia was more muted with the Nikkei (+0.1%) barely higher while both Hong Kong (-0.9%) and China (-0.6%) fell amid the Chinese tariffs remaining in place.  As to the regional markets, there were some notably gainers (Korea and Taiwan), but away from those two a more mixed picture with less absolute movement was the order of the day.  In Europe, Spain’s IBEX (+1.0%) is the standout performer after the PMI data showed only a modest slowing, and a much better result than the rest of the continent.  Perhaps this explains why the rest of the continent is +/- 0.2% on the session.  As to US futures, they are lower at this hour (7:30) on the back of weaker earnings data from Google after the close last night.

In the bond market, yields have fallen across the board (except in Japan where JGB yields made a run at 1.30%) with Treasury yields lower by 4bps this morning and 12bps from the highs seen yesterday morning.  European sovereign yields are all lower as well, between -4bps and -7bps, as the weaker PMI data has traders convinced that the ECB is going to respond to weakening growth rather than sticky inflation and are now pricing in 100bps of cuts this year with the first 25bps coming tomorrow.

In the commodity space, gold (+1.0%) is the god of commodities right now, rallying more than $100/oz over the past five sessions.  There continue to be questions as to whether this is a major short squeeze as COMEX contracts come up for delivery, but it is not hard to write a narrative that there is increased uncertainty in the world and gold is still seen as the ultimate safe haven.  This gold rally continues to pull other metals higher (Ag +0.8%, Cu +0.2%) although I have to believe this is going to come to a halt soon.  Meanwhile, energy prices have fallen again (oil -1.0%, NatGas -1.5%) as fears over supply issues have dissipated completely.

Finally, the dollar is under pressure overall, certainly one of the reasons the yen (+1.0%) has performed so well overnight, but elsewhere in the G10, we are seeing the euro, pound and Aussie all gain 0.4% or so.  In the EMG bloc, CLP (+1.0%) is gaining on that renewed copper strength while ZAR (+0.5%) is shaking off the Trump threats regarding recent legislative changes and benefitting from gold’s massive rally.  The one outlier is MXN (-0.4%) which seems to be caught between the benefits of stronger silver prices (Mexico is a major exporter of silver) and weaker oil prices.

On the data front today, we start with ADP Employment (exp 150K) then the Trade Balance (-$96.6B) and get ISM Services (54.3) at 10:00.  We also see the EIA oil inventory data with a modest build anticipated across all products.  Four more Fed speakers are on the docket but as we continue to hear from more and more of the FOMC, the word of the moment is caution, as in, the Fed needs to move with caution regarding any further rate cuts.

I don’t blame the Fed for being cautious as President Trump has the ability to completely change perspectives with a single announcement.  While yesterday was focused on Gaza, not really a financial market concern, who knows what today will bring?  It is for this reason that I repeatedly remind one and all, hedging is the best way to moderate changes in cash flows and earnings, and consistent programs, regardless of the situation on a particular day, are very valuable.

Good luck

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