Tag Archives: #fedfunds

The Die Isn’t Cast

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This morning, investors don’t know
Exactly which way things will go
Unlike in the past
The die isn’t cast
So, some pundits will eat some crow

The question is how will the Fed
Explain how they’re looking ahead?
If Warsh has his way
There’s not much they’ll say
But others, more views, want to spread

As market participants prepare for today’s FOMC statement with the potential for a rate hike, as well as the ensuing press conference, I cannot help but marvel at the recent increase in analysts doing their jobs and being forced to think about what can happen.  This is the healthiest thing about this process I believe.  It is also a very different approach than some current FOMC members have taken as they seem quite dismissive of the process.  For instance, in the WSJ article I cited yesterday, I want to highlight this paragraph;

“Governor Christopher Waller, a former economics professor with a reputation for saying what others won’t, put Warsh on the spot, according to several people familiar with the dinner. What’s the point of all this, he asked. Tell me who you’re putting on these groups, he said, and I’ll tell you what they’ll say. There were no brilliant ideas out there that everyone had somehow missed.”  

This is the very definition of hubris, Governor Waller saying he already has all the ideas and, essentially, the task forces are a waste of time.  Every member of the FOMC and every one of the 300+ or 500+ or however many PhDs who work there are Neo Keynesians and all see the world in exactly the same way.  In fact, they clearly believe that their collective view is the ‘only’ view that is correct.  And yet they have failed at their mission statement for more than 5 straight years.  My take is they are all terribly frightened that other ideas will not only be more effective, but that they will demonstrate all the mistakes the current FOMC has made prior to Chairman Warsh’s appointment.

As of 6:45 this morning, the currently priced probability for a hike, as per the Fed funds futures market, is ~38%, an unusual amount of uncertainty on the day of the meeting.  However, as you can see from the table below, there is virtual certainty of a hike in September and a high probability of one in December as well.  Personally, I disagree they will hike at all this year, but that is what makes markets.

Source: cmegroup.com

It has been two years since there has been this much uncertainty ahead of the meeting, and back then it was a question of 25bps or 50bps as a cut, which I would argue is qualitatively different then determining if there would be any action at all.  Otherwise, you need to go back quite a while to see this type of uncertainty, pre-GFC and the beginning of forward guidance.

Meanwhile, the other story of note is the Iranian attack on a US air base in Jordan and renewed fighting in the Gulf region, more than simply in Iran, which has oil prices rebounding sharply from yesterday’s lows, up 5.0% this morning.  The biggest problem with the oil market, from a market perspective, is that it is all headline risk, whether more attacks, peace talks or some other comment from either President Trump or Iran.  The one thing of which I am certain is that this conflict will not last forever and that when it is over, oil prices will fall back sharply and that over time, the Strait of Hormuz will see its transits decrease to ~5% of the global oil market, making it largely irrelevant to the conversation.

Which takes us to the market activity overnight.  Semiconductor companies continue to have some serious problems as SK Hynix reported earnings last night, which, while they beat expectations, their guidance was weaker than expected.  Given what we have seen from the sector lately, it cannot be a surprise that the KOSPI fell another -6.0% last night.  The chart below shows the relative performance of the KOSPI and NASDAQ over the past 5 years, and I have highlighted the peak.  As you can see, the KOSPI massively outperformed (and we thought the NASDAQ was a bubble!) although it is falling back to earth rapidly.  In fact, YTD, it is only higher by 34.4%, after having nearly doubled at the peak.

Source: Bloomberg.com

Elsewhere in Asia, Taiwan (-3.8%) also suffered as did the Nikkei (-1.5%) although other Japanese indices held up just fine.  China (+0.7%) and HK (+2.0%) had solid sessions and most of the rest of the region performed reasonably well.  Remember, once we get past the Fed today, all eyes will turn to Tokyo for the BOJ meeting which comes Friday.

In Europe, it is a mixed picture with concerns over the rising oil price driving some of the concern as we have also seen yields back up a bit.  Spain’s IBEX (-1.5%) is the laggard, but that appears to be a profit taking situation as the market there had rallied to record highs recently.  Elsewhere, France (-0.5%) is soft while the UK (+0.3%) is picking up slightly after some positive housing news and Consumer Credit activity while the DAX is little changed.  As to US futures, at this hour (7:40) they are edging higher, 0.25% or so.

As I mentioned, yields are backing up this morning with Treasuries (+2bps) outperforming vs. European sovereigns which are all higher by between 3bps and 4bps.  This seems entirely a reaction to the rebound in oil prices as there has not been enough other news to matter.

Metals markets are having another session where the relationship with oil is askew.  Gold is unchanged this morning while silver (+1.0%) has edged higher despite the oil rally.  But these metals remain in a downtrend trading in virtual lockstep as per the chart below.

Source: tradingeconomics.com

Finally, the dollar is mixed this morning, depending on which counterpart you watch.  The DXY (-0.1%) is a touch softer although there has not been much movement at all in the euro, pound or yen.  In the G10, AUD (-0.5%) is the worst performer after inflation data overnight was cooler than expected and the probability of a rate hike fell even further.  NOK (+0.3%) is responding to oil’s rebound and everything else is minimal.  In the EMG, ZAR (-0.5%) is the laggard du jour on the higher oil prices although in fairness, it is holding its own vs. the gold price, having only declined about 2.5% in the past six months despite the sharp, 25% decline in the price of gold.  

You can be sure that after the FOMC today, all eyes will turn to the BOJ and the yen as the next major discussion point for the FX markets.

And that’s really it today.  The only data is the EIA oil inventories with a small draw expected.  And of course, the FOMC this afternoon.  My take is not much will happen ahead of 2:00, but remember, a large portion of the market has their bet wrong as to the outcome, so if nothing else, expect some volatility in the aftermath.

Good luck

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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

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Many Critiques

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This evening the president speaks
And pundits have many critiques
Meanwhile in Iran
There’s no clear game plan
As havoc, the president wreaks

But right now, seems traders don’t care
‘Bout Persia or any warfare
Instead, soft inflation
Has changed the narration
So, pundits, high rates now foreswear

Some days, it’s simply more difficult to find stories that bring coherence to the narrative.  But let me try.  Yesterday’s PPI data was also much cooler than forecast, although still clearly quite high on a year over year basis, but it certainly added to Tuesday’s CPI result and has changed a lot of views regarding the Fed’s future actions.  For instance, if we look at my favorite CME table for current probabilities of future rate moves, we see that there is now just a 10% probability of a hike in two weeks’ time, and just one hike priced in for the next 18 months.

Remember, Monday, there was a 40% probability of a hike priced for the July meeting and two+ hikes priced through 2027.  (As I recall, I was an advocate of fading that price action.)  I expect that this will alter the narrative as calls for an immediate rate hike to burnish Warsh’s, and the Fed’s, credibility are likely to fade away.  In the meantime, he didn’t say anything new at the Senate testimony and the rest of the Fed talking heads continue to reiterate that they would be comfortable raising rates if inflation pressures rise.  Remarkably, they didn’t seem to notice the recent numbers.

Turning to the Strait of Hormuz, the US blockade of Iranian vessels is back in force and there have been a significant number of new US attacks on Iranian military sites.  As well, the IRGC has fired drones/missiles at several tankers trying to exit the Strait on the Omani side.  I read this morning that the president is considering whether to escalate things by attacking Kharg or Qeshm Islands, two key Iranian strongholds, and my guess is if that were to be the case, the oil market would likely take a turn higher.  But right now, WTI is effectively unchanged on the day, and has been since Monday’s rise.  I guess $80/bbl +/- is the new home.

Source: tradingeconomics.com

As to the President’s speech tonight, the word is it is going to involve election related issues, seemingly regarding the integrity of elections, the SAVE Act and the results of the 2020 elections.  Recall, Tulsi Gabbard, before she resigned to care for her husband, declassified a great deal of information and some portion apparently was election related.  Alas, this will simply further stoke partisan feelings as there is very little evidence that showing proof of something political has the ability to change the opposing viewpoints of partisans.

So, away from oil, we are now into earnings season, and the big banks all had monster quarters while there is growing angst over the AI sector and whether the main players will be able to make the money that was assumed for so long.  So, while yesterday saw US indices trade higher, the overnight session has been far less positive.

Starting in Asia, Tokyo (-2.8%), China (-1.9%) and Korea (-6.4%) all felt the pain of semiconductor weakness although HK (+1.3%) bucked the trend with most of the rest of the region showing far less movement in either direction.  There was precious little data to drive things, so this clearly seemed to be tech sector woes.  In Europe, broad, but modest, weakness is today’s theme with both France and Germany lower by -0.65% with Spain (-0.5%) also under pressure and the UK (-0.3%) the best of the bunch after GDP data was mildly better than the last reading at 1.3% Y/Y in May.  While the Trade Balance improved a bit, IP was weak and although it has been spun as a positive report, it hardly quickens the pulse.  Meanwhile, at 7:20 this morning, NASDAQ futures are lower by -1.1% although the other two major indices are little changed.  Tech is definitely under pressure here.

In the bond market, this morning we are seeing yields higher by basically 2bps across the board in Treasuries and European sovereigns.  Much is being made of the French OAT 30-year yield this morning as it trades to its highest level since the GFC as per the below from barchart.com.

While this headline of the highest rate in X years is splashy, what we have been seeing consistently, across all nations, is that debt issuance continues to rise and central banks have not been absorbing nearly as much as they had in the more recent past.  This means that the private sector needs to buy bonds, and they are demanding higher yields.  Someone made the point (and I cannot remember where I first read it, but it is valid) that bond yields appear to be less about inflation concerns, per se, and more about the ability for markets to absorb the ever-increasing amount of debt being issued by governments…and companies.  Just look at how much debt is being issued by the hyperscalers to fund their AI buildout.  Regardless of what happens to the front end of the curve and central bank rate activities, it does feel like the back end of the curve is where the signal is going to be found going forward.

Precious metals continue to bat about, rallying and then giving those gains back, but net remain under pressure as gold (-0.75%) and silver (-1.9%) are both softer this morning although copper (+0.7%) continues to find support.  It is difficult to look at the gold chart and be optimistic about a reversal of fortune in the near-term.  

Source: tradingeconomics.com

However, as per the discussion above regarding the increasing issuance of government debt around the world, at some point, the larger fiat vs. physical stores of value question is going to reassert itself and gold will be one of the main beneficiaries of that story.  Alas, it has a history of doing nothing from a price perspective for years on end.

Finally, the dollar, which suffered yesterday, with the DXY slipping -0.5%, is not very interesting this morning.  the pound, interestingly, has slipped -0.3% despite what many are trying to spin as a positive GDP report.  The other noteworthy mover is KRW (+0.4%) on the back of the BOK raising interest rates by 25bps to 2.75% last night.  While this was widely expected, the rhetoric about faster growth driving the need for higher rates has been a boon to the won.  (And remember, this was despite the KOSPI getting crushed last night on weakness in the two big semiconductor firms.)

On the data front, this morning brings the weekly Initial (exp 217K) and Continuing (1820K) Claims as well as Retail Sales (0.2%, -0.1% ex autos) and the Philly Fed (13.0).  With the recent surprises in CPI and PPI, I’m sure there will be a lot of focus on this morning’s Retail Sales data.  Certainly, a weak number will feed into the new, growing narrative, that the economy is slowing and rate hikes are slipping from view.  But yesterday’s Empire Mfg number was quite strong. There are still many inconsistencies in the data, which if nothing else, allows every analyst to point to something and claim they are right.

Ultimately, to me the great concern is an escalation of US activity in Iran, especially bringing troops into play.  In that case, I think things would change a lot, and we could well see another jump in oil prices.  But absent that, right now there is a lot of noise, but not much signal.  I don’t think the big picture has changed, i.e. investment into the US remains strong and that is going to support both the economy and the dollar.  But there will be many twists and turns.

Good luck

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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

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Discussing Their Plight

Posted on by 
Now, all eyes will turn to the chat
When Warsh and his minions, they sat
Round oak polished bright
Discussing their plight
‘Bout prices and jobs and all that

But since they met three weeks ago
Chair Warsh very clearly did show
His view that inflation
Was short in duration
And rate hikes were not apropos

It is getting increasingly difficult to maintain a hawkish Fed view as both the data and the Chairman are working against you.  While we all enjoy the World Cup this week, arguably the biggest market related news will be Wednesday’s release of the Minutes from the last FOMC meeting.  You may recall that in the wake of that meeting, interest rate hawks were in the ascendancy with an October hike fully priced and odds for a second, December, hike priced as well as you can see in the below CME table from June 24th.

Now, in the wake of that meeting and the press conference, the combination of the dot plot showing half the committee expecting a hike this year and the lack of forward guidance along with the succinct statement explaining the Fed would achieve their 2.0% inflation mandate had many analysts expecting a serious tightening cycle upcoming.

But a funny thing happened on the way to the next FOMC meeting, still three weeks hence, the price of oil, and energy in general, accelerated its decline.  Given how much effort was made to explain that the core inflation readings were heading higher because of the impact that energy has on everything, hence the need to hike rates, this has been an inconvenient outcome for the hawks.  Add to that Chairman Warsh’s comments at Sintra, Portugal last week, regarding the easing of inflationary pressures as energy prices decline (oil -0.9% this morning) and futures traders have been adjusting their views pretty steadily as per this morning’s CME table.

While a hike is still assumed by year end, the second one has fallen by the wayside.  Personally, as we continue to see inflation pressures subside alongside energy prices, I expect that not only will we not see a hike this year at all, but a cut by December is viable.

Adding to the downward bias on Fed funds futures was Thursday’s payroll report, where the headline number was softer than expected, although the Unemployment Rate did slip another tick to 4.2%.  I think a key problem with using the Unemployment report as such a critical signal is the fact that since President Trump’s inauguration and the actual closing of the Southern border, as well as the deportation (by both the government and on a self-basis) of somewhere between 2.5 million and 3.0 million according to Grok, the old econometric models of what type of job growth was necessary to maintain solid economic growth are no longer terribly useful. If we throw in the dramatic changes to the economy on the back of the increase in AI as a tool and infrastructure investment, it becomes increasingly difficult to utilize the old models.  Too, one of the main themes from several months ago was that AI was going to replace hundreds of thousands of jobs and unemployment would skyrocket, while now, those ideas are being rethought with many analysts now expecting AI will support more jobs.  Perhaps, the best thing that can come of this change is that markets will no longer radically adjust based on an outdated statistic.

There is still a long way to go before the next FOMC meeting and I doubt that the many task forces will have come to any conclusions yet, but if energy prices continue to decline, and I couldn’t help but notice this WSJ article discussing the sudden glut of oil driving prices lower, and I am growing increasingly confident in my views.

Which takes us to the currency that most needs to see a more dovish FOMC, the yen (-0.6%).  You may remember last week when the yen, after making yet another new low for the move, suddenly reversed course ahead of the July 4thholiday.  While there was no actual intervention, the discussion was that the MOF would no longer discuss their intentions ahead of any intervention and with a holiday weekend seeing reduced liquidity, many anticipated some action.  Well, as you can see from the chart below, that idea has essentially been erased with the yen softening again and pushing back to those lows seen last week.

Source: tradingeconomics.com

Bloomberg ran an article this morning about a former Vice Minister from the MOF explaining his view that the yen was undervalued by 20% or so.  If we look at the yen on a PPP basis, the IMF claims the value should be about 93-95 instead of the current 162+.  The Economist’s Big Mac Index calls for 78.00, and by all accounts, visiting Japan is relatively inexpensive for most foreigners.  In fact, I read that Japan was increasing the visa fees to try to discourage the massive amount of tourism as people around the world see it as a cheap destination.

Ultimately, the problem with the yen, in my view, remains that real interest rates remain deeply negative and the government’s spending plans continue to indicate massive deficits as far as the eye can see.  While reduced energy prices are a boon, the yen was falling sharply long before the Iran conflict began.  Policy changes of substance are required, and they are still uncomfortable for domestic politics.  While the pace of the yen’s decline may slow, I still see it weakening going forward.

So, let’s briefly look at markets overnight before closing.  Regarding the dollar, it is broadly stronger this morning with only BRL (+0.3%) finding any support despite their ignominious defeat to the Norwegians.  But modest slippage across the G10 is the rule, -0.1% to -0.2%, while similar movement has been observed in the rest of the EMG space.  For now, the yen remains the only interesting currency.

In the commodity markets, despite oil’s continuing slide, this morning the metals (Au -0.4%, Ag -0.6%, Cu -0.1%) are also under pressure, but that accords with the dollar’s strength.  As long as the dollar remains bid, it appears the metals markets will have difficulty gaining traction.  But if I am correct regarding the Fed and the market turning toward a more dovish view, I would look for the metals to head higher again.

In the bond market, Treasury yields (-3bps) are slipping as the market reopens after the holiday weekend, arguably following through on the softer payroll data.  European sovereign yields are little changed to lower by -1bp amid a quiet market while JGB yields (+4bps) are the notable outlier, arguably as concerns rise over the weakening yen.

Finally, equity markets remain beholden to the semiconductor and AI trade and with the US having been closed on Friday, there was less information for the rest of the world.  But this morning, NASDAQ futures (+0.9%) look like they are set to resume their march higher, dragging the S&P with them.  But this follows a mixed to lower session in Asia (Tokyo 0.0%, China 0.0%, HK +1.1%, Korea -0.5%, India +0.7%, Taiwan -0.5%) as leadership was lacking.  Not surprisingly, European bourses are also mixed this morning (Spain -0.7%, UK -0.2%), Germany and France both +0.1%) as the question of note is how much defense investment is going to be forthcoming from NATO and European nations and how much of that will be spent in Europe.  Perhaps excitement in the US will help global risk appetite as the day wears on.

On the data front, it is a quiet week for numbers with just the below on the docket:

TodayISM Services54.0
TuesdayTrade Balance-$78.0B
WednesdayFOMC Minutes 
ThursdayInitial Claims220K
 Continuing Claims1810K
 Existing Home Sales4.20M

Source: tradingeconomics.com

As well, we hear from three Fed speakers, Waller, Williams and Logan. Now it will be interesting to see if any of them start to discuss the lower energy prices and how that is likely to moderate their inflation concerns.  If we do hear something like that, I expect the Fed funds table above will reflect that quickly.  We shall see.

It is summer, and there is not much new to discuss.  With the US playing Belgium tonight, all eyes will be there, and my take is we are not looking forward to a terribly exciting session today.

Good luck

Adf

‘Pocalypse Dreams

Posted on by 
Though many have preached the buck’s dead
The greenback keeps moving ahead
And right now, it seems
Their ‘pocalypse dreams
Are still all confined to their head(s)

But narrative writers ignore
Whatever they said from before
Right now, it’s the buck
That’s causing bad luck
As rate hike bets all start to soar

In a fairly rare set of circumstances, the dollar has drawn the spotlight in markets for the past few sessions.  While it always matters to some extent, it is rarely seen as the cause of many other market movements, just a coincident one.  But right now, I read more about how the strong dollar is driving equity weakness and commodity weakness as more and more bets get placed on the Fed hiking rates aggressively to address inflation by the end of the year.

Using the DXY as proxy, the first chart is the one everybody wants you to focus on, showing the last year and how we have had a clear break above the trading range top of 100.50 and now people are creating targets for just how high it can go.

Source: tradingeconomics.com

And it certainly can go higher, as a quick step back to get some more perspective shows where the dollar has been during the past 5 years. It seems to me I could create a narrative that the dollar has been massively undervalued over the past 18 months, and this move is simply returning it closer to its longer-term fair value.  In fact, just eyeballing, it seems quite reasonable to think the 5yr average of the DXY is somewhere around 103-104 (subsequently confirmed with Grok), still a few percent higher than current levels.  Reversion to the mean anyone?

Source: tradingeconomics.com

All of this, though, begs the question, are rate hikes really on the near-term horizon?  I remain firmly in the camp that is not the case.  Fortunately, someone on my side is super smart, Bob Elliott, former hedge fund manager at Bridgewater.

On the rate hike front, the below CME probability table has barely changed from yesterday as the narrative is strong that rate hikes are coming.  

I cannot really understand why this is suddenly the belief set given the fact that the key driver of recent higher inflation data has been the price of oil, and that price continues to fall, down a further -2.0% this morning.  I understand that gasoline prices have not fallen quite as dramatically, but nothing about the chemistry has changed and I remain highly confident that those prices will be falling as well, catching down to oil.

Source: tradingeconomics.com

So, I remain confused as to why everybody seems to believe the Fed, which despite a new Chair remains the same institution that observed inflation run higher for years during Covid and calling it transitory, has become the reincarnation of the Bundesbank.  In fact, the only rationale I see is that other than Waller, Warsh and Bowman, who were all appointed by Trump, everybody else in that room has TDS and is terrified that things will work out such that by the time the election rolls around, the economy is ticking over nicely with inflation a historical issue.  And frankly, I think most of them do share that affliction.

But other than Powell, and Cook to some extent, none of them have really felt the force of the critiques that come with upsetting President Trump, and frankly he didn’t care about Cook per se, she was just a convenient target to get ousted so he could put his man in there.  And in fairness, Cook is a massive dove, and should agree with Trump on this policy, but I’m sure she doesn’t because…Trump.  I am confident none of them signed up for being in that spotlight.

Apparently, BOA is calling for 3 rate hikes this year in the final four meetings.  I think that’s nuts, but futures are pricing a 2/3 chance of a hike at the end of July, which I also think is nuts.

The recent hiccup in stocks, and the steadier downturn in commodities has been blamed on dollar strength which is being driven by expectations of rate hikes coming soon.  While I like the dollar in the long-term, that is because I believe investment flows into the US will drive it, not financial arbitrage flows.  As things evolve, I expect the market to understand the Fed will not be hiking rates and narratives will need to find a new bogeyman.

Ok, let’s tour markets quickly.  Yesterday’s equity market selloff in the US, following the tech selloff in Asia closed well off the lows and futures this morning are pointing slightly higher.  Asia was mixed overnight with Korea (+3.3%) rebounding sharply although there was weakness in Japan (-0.9%), Taiwan (-2.25%), Indonesia (-3.6%) and the Philippines (-2.2%).  But on the flip side, China (+0.5%), HK (+0.3%) and India (+1.0%) all followed Korea while other regional exchanges had much more limited movement.  It appears that people are trying to figure out what to do for now.

In Europe, Germany (-1.0%) is the laggard after Germany cancelled its plans for a new warship and Rheinmetall, the company set to win biggest there, got crushed.  But elsewhere +/-0.3% or less is the norm with little new information as traders await the next shoe to drop.

In the bond market, interest is low as 10-year Treasury yields continue to track around the 4.5% level and movement has been 1bp or so lower across all of Europe.  Nothing to see here for now.  Just wait until views start to change on rate hikes though!

Metals markets continue to get hammered with gold (-1.7%), silver (-2.9%) and copper (-1.6%) all still falling as the opening narrative about higher rates and a stronger dollar play out.  The thing is, I think the fundamentals remain positive for metals markets as there continues to be central bank demand for gold as well as industrial interest in silver and copper and long-term shortages of supply.  But right now, none of that matters.

Finally, looking beyond the DXY, it is no surprise the euro (-0.35%) and pound (-0.35%) are lower given the DXY’s continued rise, but the yen (-0.1% and at a new low (dollar high) for the move) continues to slide and there is weakness pretty much across the board in both the G10 and EMG blocs.  KRW (-1.0%) is today’s laggard while INR (+0.2%) is the lone currency holding its own.  This continues to be a dollar focused story so when the rates story changes, so will the dollar.

On the data front, we see New Home Sales (exp 640K) and then EIA Oil inventories with yet another large draw expected.  And that’s it for today.  As long as this rate hike narrative remains primary, look for weaker risk appetite and a strong dollar.  But I think it is a short-term phenomenon.

Good luck

Adf

What’s Next To Be Feared?

Posted on by 
For Holmes, when the dog didn’t bark
He recognized that was the spark
To solving the case
And so, we must brace
For narrative changes quite stark

This morning, no headline appeared
Regarding Iran, which is weird
Have markets moved past
This problem, at last?
And if so, what’s next to be feared?

So, perusing the WSJ on-line this morning, the notable absence was any story on Iran and the current situation regarding the ongoing peace talks.  There was a throwaway article about Trump and what he has said about Iran, but nothing of substance.  Part of me is amazed that this is the case as the conflict would still seem to be the most important issue in the markets given the impact on oil prices and inflation, as well as its general geopolitical impact.  But part of me cannot be surprised at all.  It’s not just traders who have the attention span of a fruit fly, apparently so does the general public.

I made the point several weeks ago that this conflict would fade into history quickly when it was ending based on the fact that the Venezuela incursion, back in January, fell from headlines within about three days.  Given the generic MO for most publications of, if it bleeds, it leads, the fact that bombs are no longer falling, and peace talks are ongoing is no longer that interesting.  Add to that the generic TDS of most of the media, where they loved to play up rising oil prices as a major policy failure for Trump, now that those prices have been falling for the past 11 weeks and have slipped >30% in that period, and quite frankly, have further to fall, most editors have moved on.  If they cannot tar Trump with a policy failure, they would rather not discuss the subject at all.

Source: tradingeconomics.com

So, here we are this morning with the market now turning its focus to an ostensibly hawkish Fed despite the recent analysis by the BLS indicating that more than 60% of the recent uptick in inflation was driven by the rise in energy costs.  So, with energy costs reversing course dramatically, what does that say about their impact on inflation and exactly how hawkish does the Fed need to be in that case.

Right now, equity markets are under some pressure as some of the euphoria associated with the rising tech sector’s stock prices and the ongoing AI mania, is wearing a little thin.  And let’s face it, things certainly seemed a bit bubblicious.  But the combination of ongoing fiscal support from the OBBB and tax cuts and declining energy prices is likely to help support things going forward.  No matter the timeline you observe, we have seen a remarkable rally in tech stocks, as evidenced by the NASDAQ’s chart below.  A correction to the 50-day moving average would hardly be surprising, nor would it be damaging to the overall market structure, I think, although it would almost certainly result in ‘end of days’ headlines!

Source: tradingeconomics.com

So, while futures this morning are lower across the board (NASDAQ -2.9%, SPX -1.4%, DJIA -0.6%) as of 6:40am, and we could easily see some weakness for a few more days/weeks as positions shake out, I am not in the camp of things are about to collapse.

Speaking of equity markets, the overnight session was filled with red ink led by the KOSPI (-10.0%) in South Korea, although there was weakness pretty much everywhere (Nikkei -3.6%, CSI 300 -2.8%, Hang Seng -1.8%) with India and Taiwan also slipping more than -1.0% although Australia, NZ and Singapore had more muted declines.  Tech was clearly under pressure.  Of course, we cannot be surprised that European shares are also lower in a generally weak risk scenario, but given the lack of tech companies headquartered there, the declines have been far less significant (DAX -1.0%, CAC -0.6%, IBEX -0.2%, FTSE 100 -0.2%) although the Netherlands (-1.3%) home to ASML, the only tech name of note on the continent, is underperforming as well.

Meanwhile, the bond market has peeked at the oil market and decided, perhaps inflation is not a chronic condition, or at least not as bad as previously feared.  Yields are lower across the board with Treasuries (-3bps) leading the way while European sovereigns are all lower by between -3bps and -4bps.  Overnight, though, JGB yields could make no headway lower as the yen continues to be under enormous pressure.

Speaking of the yen, it continues to slowly weaken despite prominent statements by Japanese FinMin Katayama about her discussions with Treasury Secretary Bessent and their agreement to have the US coordinate with Japan in the event it is decided something needs to be done in the markets.  But so far, no signs of actual intervention.  A look at the chart below shows a very slow and steady climb in the dollar, and frankly, I do not see what will change this trajectory.

Source: tradingeconomics.com

While interest rates aren’t the only driver, they still have a key impact, and they are the one thing that can be changed quickly.  In fact, the best hope for the yen, in my view, is the fact that at some point soon, the market is going to understand the Fed is not about to raise rates again, and the next move will likely be lower, albeit not until later in the year.  but that change in tone will change a lot of opinions on how the yen should behave, and a move back toward 155 amid modest overall dollar weakness could easily be seen.  But right now, everybody is of the opinion that the FOMC is going to hike this year, and Japan cannot afford to be aggressive in that context, hence the yen’s weakness.

Here is a forecast I do not make lightly, Fed funds will finish the year lower than they are now, probably 3.25%-3.50%.  And the current Fed funds futures market has bottomed (rates peaked) as per the CME table below.

As to the rest of the FX world, the dollar reigns supreme this morning as the euro (-0.3%) is below 1.1400 this morning, its weakest in more than a year as the Flash PMI data did it no favors, but the new hawkish Fed, higher US rates strong dollar narrative has been the driver.  We have seen the same type of movement elsewhere, except where the dollar has moved further, with AUD (-0.8%) the worst performer in the G10 although HUF (-1.0%) is actually the biggest laggard.  However, given the overall decline in commodity prices, those currencies that benefit from rising commodities are also under pressure (NOK (-0.7%, ZAR -0.5%, SEK -0.8%, MXN -0.7%) and we already discussed AUD.

Lastly, the metals markets are also under serious pressure with gold (-1.6%), silver (-4.5%) and copper (-3.3%) all tumbling on the same new view of higher rates and a stronger dollar.  The thing about the commodities story is the fundamentals still seem positive to my eyes, and this seems like the last of the fluff getting taken out.

On the data front, Thursday’s PCE data is the big day and here’s what we have overall:

TodayFlash Manufacturing PMI54.8
 Flash Services PMI51.0
WednesdayNew Home Sales640K
ThursdayInitial Claims225K
 Continuing Claims1800K
 Q1 GDP Final1.6%
 Personal Income0.4%
 Personal Spending0.6%
 PCE0.5% (4.0% Y/Y)
 Core PCE0.3% (3.4% Y/Y)
 Durable Goods-4.3%
 -ex Transport0.7%
FridayMichigan Sentiment50.3

Source: tradingeconomics.com

In addition to the data, we start to hear from some of the FOMC members, although I am confident Chairman Warsh won’t be out and about.  Some analysts claim that Warsh’s view of less communication is going to weaken him as others will get to make their point and he won’t be able to counter it.  But I think that Warsh has a plan, and if we continue to see oil prices decline, which seems the likely outcome, then all the inflation fears are going to dissipate and by the time the next meeting rolls around, it will be far harder to make the case that tighter policy is necessary.  Historically, hiking into an energy price shock has been a central banking mistake, and I think Warsh knows this and is keen not to repeat it.

Net, for now, everybody loves the dollar and hates risk on this new hawkish Fed narrative.  But going forward, I like the dollar on the back of a better economy and better investments and expect that the hawkish Fed narrative is going to fade away.  But I’m just an FX poet.

Good luck

Adf

A Slippery Slope

Posted on by 
For one day, at least, there was hope
The war might be shrinking in scope
But as of this morning
The markets are warning
That there’s still a slippery slope

The Strait is still under duress
Though some ships have found an egress
The truce is still frail
And much can still fail
Beware, we’re not past all the stress

The most interesting story, to me, about the cease fire is that Pakistan gave each side different terms so they both agreed to something different.  This might explain the confusion over whether the Israeli attacks in Lebanon were part of the deal, and the question about Iran’s collection of tolls for passing through the Strait of Hormuz.  On the one hand, that very duplicity calls into question the help that Pakistan actually offered in this process.  Of course, the other side is, if that subterfuge is what got the two sides talking directly, and apparently VP Vance is on his way to do that, then it was very worthwhile.  It is still far too early to determine if the fighting is going to stop and if the Strait is going to fully reopen soon, but talks are better than no talks, at least in my view.  

As to who ‘won’ the war, that question will take a long time to answer.  After all, whatever the short-term impacts, if Iran is dramatically weakened and its sponsorship of terrorism is eliminated, the world will have won the war, certainly the Middle East as a whole, as it will make for a much safer place.  However, if the radical wing of the regime there remains in charge and continues to press its global ambitions, then nobody will have won the war, not the rest of the Gulf nations and not the Iranian people themselves.  

In the meantime, since I am not going to bring about world peace, let’s see how markets are behaving.  After all, they really do offer some insight into global affairs as price information is some of the best information available.

After yesterday’s sharp decline in oil prices, we have seen a bounce this morning (+5.0%) although as I type at 6:50, it remains just below $100/bbl.  You can see from the chart below of the past month that we’re kind of in the middle of the range.  Alyosha (read Market Vibes on Substack) explains the Point of Control as the place where a market trades most frequently during a given period of time.  His records show that $94/bbl is that number in WTI, a level we touched and have since bounced from.  Headlines continue to be the driver, and I suppose that the next key headlines will be comments regarding the peace talks.

Source: tradingeconomics.com

NatGas prices (+0.3% in US, +2.0% in Europe) are also rebounding, but not nearly as dramatically.  In a way that is surprising as the Iranian attack on Ras Laffan, Qatar’s main LNG facility has inflicted significant damage, sufficient to cause multiple years of reduced production, yet gas has not been nearly as impacted despite its critical importance to the global economy. 

As to metals markets, gold (+0.4%) continues to find support, but is still far below the highs seen in January, and silver (0.0%) is at a loss for its next move.  On the one hand, silver, especially given its multiple industrial uses, seems likely to have significant long-term support, but right now, along with gold, it feels like owners are still liquidating as they need cash, and speculators aren’t interested yet. I still like both in the long run.

Turning to equities, yesterday’s huge rallies culminated with every major US market gaining 2.5% or more. But that seemed to be the peak, for now at least.  Overnight, Tokyo (-0.7%), China (-0.6%) and HK (-0.5%) all slipped a bit and that was emblematic of most of Asia with Korea (-1.6%), India (-1.2%) and most other markets slipping.  The few gainers (Australia, Taiwan, Indonesia) all managed gains on the order of just 0.2% or so, hardly inspiring.

In Europe, the Bloomberg screenshot explains things well, as yesterday’s euphoria gives way to more circumspection this morning, at least for now.  However, as you can see, equities remain far closer to their highs, than lows based on the gains over the past year.

There was some data this morning showing German IP far weaker than expected at -0.3% after a revised 0.0% print in January.  With this in mind, it is understandable that the DAX is lagging, and it seems ever more likely that Germany is going to have yet another quarter with no economic growth.  Looking at US futures, at this hour (7:10) they are all sitting lower by -0.3% or so.

In the bond market, Treasuries (-1bp) are the outlier this morning as all European sovereign yield are higher between 4bps and 6bps.  Yesterday’s euphoria over the potential end of the fighting and the decline in energy prices is being rethought as, undoubtedly, even if a peace treaty is agreed and signed over the next two weeks, there are going to be major impediments to the resumption of the pre-war status quo, if it ever returns.  I also suspect that investors here are growing concerned that after the European response to this military action, fears the US is going to exit NATO (NATO General Secretary Mark Rutte spent 3 hours behind closed doors in the White House yesterday with no comments afterwards) means that Europe is going to have to borrow and spend even more on their own defense.  This will, of course, strain the budgets as the turn from butter to guns may be a difficult one politically.

Finally, the dollar this morning is mixed.  It should be no surprise that NOK (+0.6%) is leading the way as oil rebounds, although three other major oil producers, CAD, MXN and BRL are essentially unchanged in the session.  The euro (+0.15%) has continued a touch higher from yesterday while the yen (-0.25%) is slipping a bit.  As I said, it is a mixed session overall with no direction of which to speak.

Turning to the data, this morning we get the regular Initial (exp 210K) and Continuing (1840K) Claims as well as the final look at Q4 GDP (0.7%).  But in addition, we get the February PCE data suite, which typically comes at the end of the following month, but given the ongoing issues from the shutdown, seem to be behind.  Expectations are for Personal Income (+0.3%), Personal Spending (+0.5%), PCE (0.4%, 2.8% Y/Y) and core PCE (0.4%, 3.0% Y/Y).  And those numbers are from before the war.  Arguably, of much more importance is tomorrow’s March CPI data, which we can discuss tomorrow.

Yesterday saw yet another build in oil inventories in the US, something which will eventually lead to lower prices, and the FOMC Minutes explaining that they were concerned about both inflation and employment.  In the meantime, a look at the Fed funds futures market shows that the market is pricing even less chance of a rate cut in 2026 with the first one now not assumed until June 2027.

The thing about futures pricing, though, is that while it does give a good sense of sentiment, it is subject to change quickly on new news.  There is much to be said about watching the 2yr Treasury note as the best predictor of Fed funds going forward and you can see how tight that relationship is in the chart below.

Source: tradingeconomics.com

My view on inflation is not that sanguine, and I fear it is going to remain far higher than the Fed’s 2.0% target for Core PCE for a long time to come.  Ultimately, that plays into my views on owning things that hurt when they fall on your foot, or shares in companies that generate profits.  (This is where I also mention USDi, for those of you inclined in the crypto space, as the only inflation-tracking currency around.  Learn more at http://www.usdicoin.com)

As to today, this is the rebound and since nobody knows what will play out in the talks, I would look for a choppy, but inconclusive session in pretty much everything.

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

Basically Fictive

Posted on by

For Fedniks it must be addictive
To say rates are “somewhat restrictive”
It seems like a show
As how can they know
Since R-star is basically fictive
 
Investors, though, lap up this stuff
In fact, they just can’t get enough
Of comments that hint
There is a blueprint
For policy, though that’s a bluff

 

Yesterday, both Richmond Fed president Barkin and Governor Jefferson explained that current Fed policy is “somewhat restrictive”.  This takes to seven the number of FOMC members who have used this phrase with Powell, Kugler, Hammack, Schmid and Collins all having used it before, as did Jefferson two weeks ago.  And they are all referring to the concept of R-star, the mythical rate at which policy is neither restrictive nor accommodative.  In fact, R-star has become the Fed’s north star, with the key difference being, we can actually see the north star while R-star, even they will admit, is unobservable.  Of course, that hasn’t stopped them from basing policy decisions on the variable.

I highlight this because the tone of virtually every one of these speeches has been one of caution, with the implication being they are very close to their nirvana so the last steps will be small.  However, we cannot forget that though the last steps may be small, there is still confidence amongst the entire body that the direction of travel is toward lower rates. certainly, as you can see from the aggregated meeting probabilities from the Fed funds futures market below, there is zero expectation that rates will rise anytime during the next two years and a decent chance of another 100bps of cuts over that time.

Source: cmegroup.com

I might contend that is a pretty negative outlook on the US economy by the Fed.  Given the Fed’s models assume that a key to lower inflation is slowing economic growth, the idea that rates are going to fall implies slower growth to help them achieve the inflation portion of their mandate.  But that seems out of step with both the Atlanta Fed’s GDPNow forecast shown below and currently sitting at 4.1% annualized for Q3 and with earnings forecasts in the equity markets.

Asking Grok, the average current earnings growth forecasts for 2026 for the S&P 500 is somewhere in the 13% – 14% range with revenue growth running at ~6.9%, which is typically in line with nominal GDP growth.  (I understand that current forward PE ratios are extremely high at 23x, so be careful that companies hit their targets while their share prices fall anyway.)  But if nominal GDP is going to run at nearly 7%, and let’s assume inflation is at 3.5%, which I think is a reasonable possibility, then the math tells us that GDP is growing at 3.5% on a real basis.  With Fed funds currently at 4.0%, why would they need to decline further?

Looking back at the Fed’s September Summary of Economic Projections, it appears that the Fed sees a very different economy than the markets see.  In fact, you can see that they believe nominal GDP in the long run is going to average <4.0% (sum of longer run GDP and PCE in the table below).  

That is a really big difference, one that is the type that can lead to massive policy errors.  Now, if those 17 people cloistered in the Marriner Eccles building have a better handle on the economy than everybody else, I can understand why they believe rates need to fall further.  But is that the case?  

Here’s something else to ponder, I asked Grok about the relationship between nominal GDP and Fed funds and the below table is what it produced:

It is patently obvious how the Fed has developed its models and because of that, why they have been so wrong.  In fact, look at the SEP above and compare it to the period from 2001 – 2019, they are essentially identical.  But I would argue, and I’m not alone, that the economy from the dot.com crash up to the pandemic is no longer the reality on the ground.  The Fed’s backward-looking models seem set to make yet more errors going forward.

And with those cheery thoughts, let’s look at what happened overnight.  Yesterday’s continuation of the US stock decline seems to be finding a bottom, at least temporarily as Asian markets were mixed (Nikkei -0.3%, Hang Seng -0.4%, CSI 300 +0.4%) with the rest of the region showing a similar mixture of gainers (India, Malaysia, Indonesia, Philippines) and losers (Korea, Taiwan, Australia) as it appears the entire world is awaiting Nvidia’s earnings after the US close today.

Similarly, European bourses are edging higher this morning with the rout seemingly over for now.  This morning Spain (+0.5%) is leading the way higher followed by Germany (+0.3%) with the rest of the markets little changed overall, although leaning higher.  As to US futures, at this hour (7:30) they are pushing higher by about 0.4%.

In the bond market, Treasury yields are unchanged this morning, still sitting right around that 4.10% level while European sovereigns have seen demand with yields slipping -2bps to -3bps across the continent.  The UK is the outlier here, with yields unchanged after releasing inflation data that was bang on expectations, and below last month’s readings, though remains well above their 2.0% target.  I guess if I look at the chart below, I might be able to make the case that core UK CPI is trending lower, but similarly to the Fed, the last time they were at their target was July 2021.

Source: tradingeconomics.com

I would be remiss if I didn’t mention that JGB yields have moved higher by 3bps, pushing their decade long highs further along as concerns grow over the Japanese fiscal situation.

Oil prices (-2.4%) are falling this morning, slipping to the low side of $60/bbl after API inventories showed a surprise build of 4.4 million barrels.  However, I would contend that there is very little new here.  Perhaps the dinner last night where President Trump hosted Saudi Prince MbS has some thinking OPEC will increase production more aggressively going forward.  In the metals markets, they are all shining this morning led by silver (+3.1%) and platinum (+3.0%) with gold (+1.3%) and copper (+1.3%) lagging, although remember the latter two are much larger markets so need more interest to rise as quickly.

Finally, the dollar continues to find support, despite the precious metals gains, and this morning we see the DXY (+0.15%) pushing back toward that psychological 100.00 level.  JPY (-0.5%) has traded through 156 and certainly seems like it wants to push back to its YTYD highs of 158.80.  Interestingly, there was no Japanese commentary of note last night, but I presume if this continues, the MOF will be out warning of potential future action.  Another interesting fact is that while the dollar is firmer against virtually all G10 currencies, the EMG bloc is holding its own this morning led by HUF (+0.6%), PLN (+0.25%) and ZAR (+0.15%) with the rand obviously benefitting from gold’s rally.  The forint has benefitted from the central bank maintaining policy on hold at 6.5%, one of the highest available rates in Europe and that has helped drag the zloty along for the ride.

On the data front, this morning we see the August Trade Balance (exp -$61.0B) and then the EIA oil inventories where a small draw is expected.  We also get the FOMC Minutes at 2:00pm and hear from NY Fed president Williams this afternoon.

I cannot help but look at the difference between the Fed’s very clear view and the markets expectations and feel like the Fed is on the wrong side of the trade.  It is for this reason I fear higher inflation and ultimately, a much lower likelihood of further rate cuts.  If that is the case, the dollar will find even more support.  Interesting times.

Good luck

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