Tag Archives: #fedfunds

Panic They’re Sowing

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While eyes and ears focus on Jay
And whatever he has to say
Poor Germany’s shrinking
And it’s wishful thinking
Japan’s kept inflation at bay
 
But fears about Jay have been growing
That rate cuts he will be foregoing
If that is the case
Most traders will race
To sell things while panic they’re sowing

 

Clearly, the big story today is Chairman Powell’s speech with growing expectations that he will sound more hawkish than had previously been anticipated.  Recall, after the much weaker than expected NFP data was released at the beginning of the month, it appeared nearly certain that the Fed was going to cut at the next meeting with talk of 50bps making the rounds.  Now, a few hours before Powell steps to the podium, the futures market is pricing just a 71% probability of that rate cut with a just two cuts priced in for 2025 as per the CME’s own analysis below:

Arguably, this is one reason that equity markets have been having trouble moving higher as the Mag7 drivers of the market are amongst the longest duration assets around, so higher rates really hurt them.  While there has been a rotation into more defensive names, if opinions start to shift regarding the magnificence of AI, or perhaps just how much money they are spending on it and the potential benefits they will receive, things could get ugly.

I also find it interesting that the Fed whisperer, Nick Timiraos at the WSJ, has been running flack for Chairman Powell in this morning’s article, trying to get people to focus on the Fed’s framework as the basis of today’s speech, rather than policy per se.  Briefly, the current Fed framework, was designed right before COVID when for whatever reason they were concerned that low inflation was a problem, and they created Average Inflation Targeting (AIT) as a way to allow inflation to run above their target of 2.0% for a period if it had been below that level for too long.  We all know how well that worked out and, in fact, we are all still paying for their mistakes every day!  The word is they are going to scrap AIT although it is not clear what they will come up with next.  It is exercises like this that foment the ‘end the Fed’ calls from a growing group of monetarist economists and pundits.

At any rate, comments from other Fed speakers indicate that most are not yet ready to cut rates, so Powell will be able to have a significant impact if he turns more dovish.  But we have to wait a few more hours for that so let’s turn our attention elsewhere.

Germany GDP data (-0.3% Q/Q, +0.2% Y/Y) was a few ticks lower than expected and continues to point to an economy that has no positive momentum at all.  In fact, a look at the quarterly GDP data from Germany paints a pretty awful picture if growing your economy is the goal.

Source: tradingeconomics.com

Clearly, the US tariff changes have been quite negative, but in fairness, Germany’s insane energy policy is likely a much bigger driver of their problems as they have the most expensive power costs in the EU.  It is very difficult to have a manufacturing-based economy if you cannot power it cheaply.  Again, while the euro is more than just Germany, this does not bode well for the single currency.

Turning to Japan, inflation continues to run far above their 2.0% target, printing last night at 3.1% on both the headline and core metrics, which while 2 ticks lower than June’s data, was still a tick higher than expected.  It has now been 40 consecutive months that core CPI in Japan has been above the BOJ’s 2.0% target and Ueda-san continues to twiddle his thumbs regarding raising rates.

Source: tradingeconomics.com

It is very hard to watch this lack of policy response to a clear problem, that from all I read is becoming a much bigger political issue for PM Ishiba, and have confidence that the yen is going to strengthen any time soon.  Back in May, the talk was of the unwinding of the carry trade.  All indications now are that it is being put back on in significant size.  FWIW I think we will see 150.00 before too long, especially if Powell sounds hawkish.

And those are really the stories today ahead of Powell and the NY open.  So, let’s see how things behaved overnight.  After a modest down day in the US yesterday, and despite the poor inflation data, Japan was unchanged overall.  However, China (+2.1%) had a huge up move apparently on the idea that US-China trade tensions are easing and despite continued weak data from the country.  Apparently, there has been a rotation from bonds to stocks by local investors driving the move.  Hong Kong (+0.9%) also had a strong session as did Korea (+1.0%) although India, Taiwan and Australia all struggled with declines between -0.6% and -1.0%.  In Europe, the. screens are green, but it is a pale green with muted gains (DAX +0.1%, CAC +0.25%, IBEX +0.4%) despite the weak German data.  Perhaps the belief is this will encourage the ECB to ease policy further.  Meanwhile, at this hour (7:15) US futures are pointing higher by 0.25% or so.

In the bond market, after climbing a few basis points yesterday, Treasury yields are unchanged, trading at 4.33%, so still range bound.  European sovereign yields are softer by -1bp to -2bps, again likely on the softer German data with hopes for a more aggressive ECB.  JGB yields edged higher by 1bp in the 10-year but the longer end of the curve there has seen yields move to new all-time highs with 30-year yields up to 3.216%. it feels like things are starting to unravel in Japanese bond markets.

Turning to commodities, oil (+0.4%) is creeping higher again this morning but remains in its downtrend and activity is lacking.  Meanwhile, the metals markets (Au -0.35%, Ag -0.5%, Cu -0.3%) are all under pressure from a combination of a strong dollar and a lack of investor interest, at least in the West.

Speaking of the dollar, it rallied yesterday and is largely continuing this morning with one notable exception, KRW (+0.75%) which benefitted from trade data showing exports rose 7.6% in the first 20 days of the month on strong semiconductor sales.  But otherwise, +/-0.3% or less is the story of the day, with most currencies within 0.1% of yesterday’s closing levels.

And that’s really it.  There is no data so we are all awaiting Powell and then anything that may come from the White House regarding trade deals, or peace, I guess.  As the summer comes to a close, unless Powell says rate hikes are coming or promises cuts, I expect that traders will have gone for the weekend by lunch time and it will be a very quiet market.

Good luck and good weekend

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Quite Clearly Concerned

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The data on Friday exceeded
All forecasts, and has now impeded
The idea the Fed
When looking ahead
Believes further rate cuts are needed
 
Meanwhile from the Chinese we learned
Their exports are still widely yearned
But imports are falling
As growth there is stalling
And Xi is quite clearly concerned

 

Under the rubric, even a blind squirrel finds an acorn occasionally, my prognostications on Friday morning turned out to be correct as the NFP number was much stronger than expected, the Unemployment Rate fell, and signs of labor market strength were everywhere.  One of the most interesting is the number of quits rose to 13.8%, its highest level in several years and an indication that there is growing confidence amongst the labor force that jobs are available if needed.  As well, as you all are certainly aware, the market responded by selling equities and bonds while reducing the probability of Fed rate cuts this year.  In fact, this morning, the market is pricing in just 24 basis points of cuts for all of 2025, in other words, one cut only.  

Meanwhile, the bond market continues to sell off with yields rising another 2bps this morning.  the chart below shows the dichotomy between Fed funds and 10-year Treasury yields.  Historically, when the Fed was cutting or raising rates, the bond market followed.  But not this time.

Source: tradingeconomics.com

There have been many explanations put forth by analysts as to why this is the case, but to me, the most compelling is that investors disagree with the Fed’s analysis of the economy and, more specifically, with their pollyannaish tone that inflation is going to magically return to 2% because their models say so.  In fact, when looking back over the past 50-years of data, this is the only time that I can see when this dichotomy even existed.

Source: tradingeconomics.com

If I had to guess, there is going to be a lot more volatility coming as previous market signals, and more importantly, Fed market tools, no longer seem to be working as desired.  Nothing has changed my view that 10-year yields head to 5.5%, and if I am correct, look for equity markets to suffer, perhaps quite a bit.

The other story of note overnight was the Chinese trade surplus, which expanded to $104.8 billion in December which took the 2024 surplus to $1.08 trillion.  Now, much of this seems to be preordering of Chinese goods ahead of Trump’s inauguration and the promised tariffs.  But China’s surplus with other Asian economies also grew dramatically last year.  Remember, President Xi is desperate to achieve 5% growth (even on their accounting) and since the Chinese public remains unenthusiastic about spending any money given the $10 trillion hole in their collective savings accounts due to the property market collapse, Xi is reliant on exporting as much as possible.  While this is not making him any friends anywhere else in the world, it is an existential issue for him, so he doesn’t really care.  It will be very interesting to see just how the Trump-Xi relationship moves forward and what concessions are made on either side.

In the end, while the renminbi is basically unchanged this morning, it remains pegged against its 2% limit vs. the CFETS fixing onshore and is 2.35% weaker in the offshore market.  That pressure is going to continue until either the Chinese step up, apply significant stimulus to the domestic economy and start to rebalance the trade process or the PBOC lets the currency go.  Remember, too, Xi is in a tough position because he continuously explained that the renminbi is a good store of value and has been asking his trading partners to use it rather than the dollar.  But if he lets it slide, that will destroy that entire narrative, a real loss of face at the very least, and potentially a much bigger economic problem.  Interesting times.

And so, let us turn to the overnight market activity and see how things are shaping up for today and the rest of the week.  Friday’s sharp decline in US equity indices was followed by similar price action throughout Asia (Nikkei -1.05%, Hang Seng -1.0%, CSI 300 -0.3%, Australia -1.25%) as the narrative is struggling to come up with a positive spin absent further US rate cuts.  European bourses have also come under pressure (DAX -0.7%, CAC -0.8%, IBEX -0.7%, FTSE 100 -0.4%) despite the fact that ECB talking heads continue to explain that more rate cuts are coming, they just won’t be coming quite as quickly as previously expected.  At this point, the market is pricing in 84bps of cuts by the ECB this year.  And yes, US futures are also in the red at this hour (7:00), falling between -0.5% (DJIA) and -1.1% (NASDAQ).

It seems that the narrative writers are struggling to put together a bullish story right now as inflation refuses to fall while growth, at least in Europe, continues to abate.  At least, a bullish story for equities and bonds.  The dollar, on the other hand, has gained many adherents.

Turning to bonds, yields continue to climb across the board with European sovereign yields rising between 2bps (Germany) and 8bps (Greece) and everything in between.  It seems nobody wants to hold bonds right now.  The same was true overnight in Asia where the best performer was the JGB, which was unchanged, but other regional bond markets all saw yields rise between 3bps (Korea) and 9bps (Australia).  Even Chinese yields edged higher by 1bp!

In the commodity space, oil (+2.0%) is en fuego, as the impact of further sanctions on the Russian tanker fleet is being felt worldwide.  It seems the Biden administration has added another 150 Russian tankers to the sanctions list along with insurance companies, and so China and India, who have been the main recipients of Russian oil, are seeking supplies elsewhere.  As long as this continues, it appears oil has further to run.  Meanwhile NatGas (+3.8%) has blasted through $4.00/MMBtu and is now at its highest level since December 2022.  Despite all those global warming fears, the recent arctic blast has increased demand dramatically!

As to the metals markets, the story is different with gold (-0.5%) sliding alongside silver (-2.1%) and copper also trickling lower (-0.15%).  Part of this is clearly the dollar’s strength, which is impressive again today, and part is likely concern over how things are going to play out going forward between the US and China as well as the overall global economy.  Certainly, a case can be made that growth is going to be much slower going forward.

Finally, the dollar is king again, rallying sharply against the euro (-0.5%) and pound (-0.8%) with smaller gains against the rest of the G10 (JPY excepted as it rallied 0.2% on haven flows).  But we are also seeing gains against virtually all EMG currencies (CLP -0.6%, PLN -0.7%, ZAR -0.4%, INR -0.6%) as concerns grow that these other nations will not be able to ably fund their dollar debt as the dollar continues to rise.  FYI, the DXY (+0.35% to 110.07) is at its highest level since October 2022 and looking for all the world like it is going to take out the highs of that autumn at 113.20.

On the data front, this week brings CPI and PPI as well as Retail Sales.  In addition, I was mistaken, and the Fed is not in their quiet period so we will hear a lot more from them this week as well.

TuesdayNFIB Small Biz Optimism100.8
 PPI0.3% (3.4% Y/Y)
 Ex food & energy0.3% (3.7% Y/Y)
WednesdayCPI0.3% (2.8% Y/Y)
 Ex food & energy0.2% (3.3% Y/Y)
 Empire State Manufacturing4.5
 Fed’s Beige Book 
ThursdayInitial Claims214K
 Continuing Claims1870K
 Retail Sales0.5%
 Ex autos0.4%
 Philly Fed-4.0
FridayHousing Starts1.32M
 Building Permits1.46M
 IP0.3%
 Capacity Utilization76.9%

Source: tradingeconomics.com

As well, we hear from five Fed speakers over six venues.  Now, the message from the Fed has been pretty unified lately, that caution and patience are appropriate regarding any further rate cuts but that to a (wo)man they all believe that inflation is heading back down to 2.0%.  I’m not sure why that is the case because if you look at the data, it certainly has the feeling that it has bottomed, and inflation rates are turning higher as you can see from the below chart of core CPI.

Source: tradingeconomics.com

And this is before taking into account that energy prices have been soaring lately!  I realize I’m not smart enough to be an FOMC member, but they certainly seem to be willfully blind on this issue.

At any rate, certainly all things still point to a higher dollar going forward, and I imagine we are going to test some big levels soon enough (parity in the euro, 1.20 in the pound) but I am beginning to get uncomfortable as so many analysts have come around to my view.  Historically, if everybody thinks something is going to happen, typically the opposite occurs.  Remember, markets are perverse!

Good luck

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Great Expectations

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In Europe, the largest of nations
Is faltering at its foundations
The ‘conomy’s sagging
And tongues are now wagging
‘Bout voting and great expectations
 
Alas for the good German folk
The government’s turned far too woke
Their energy views
Have caused them the blues
And soon they may realize they’re broke

 

With elections clearly on almost everybody’s mind, it can be no surprise that the crumbling government in Germany has also finally accepted their fate and called for a confidence vote to be held on December 16 which, when Chancellor Olaf Scholz loses (it is virtually guaranteed), will lead to a general election on February 23, 2025.  As has happened in literally every election held thus far in 2024, the incumbents are set to be tossed out.  The problems that have arisen in Europe, with Germany being ground zero, is that the declarations by the mainstream parties to avoid working with the right-wing parties that have garnered approximately 25% of the population’s support almost everywhere, means that the traditional parties cannot create working coalitions that make any sense.  After all, the German government that is collapsing was a combination of the Center-left Social Democrats, the far-left Greens and the free market FDP.  That was always destined to fail so perhaps the fact it took so long is what should be noted.

At any rate, it is not hard to understand why the people of Germany are unhappy given the economic situation there.  The economy hasn’t grown in more than two years, basically stagnating, while inflation continues to run above 2%.  Meanwhile, energy prices have risen sharply as a consequence of their Energiewende policy; the nation’s attempt to achieve net zero CO2 emissions.  However, not only did they shutter their nuclear generating fleet, the most stable source of CO2 free electricity, they decided that wind and solar were the way forward.  Given that there are, on average, between 1600 and 1700 hours of sunshine annually (4.3 to 4.5 hours per day), that seemed like a bad bet.  The results cannot be surprising as Germany energy costs are amongst the highest in the world.  The below chart shows electricity prices around the world.

Source: statista.com

If you want a good reason as to why incumbent governments around the world are falling, you don’t have to look much further than this.  Meanwhile, this morning brought the German ZEW Economic Sentiment Index which printed at 7.4, well below both last month and expectations.  As well, the Current Conditions Index fell to -91.4, which while not the lowest ever, certainly indicates concern given -100 is the end of the scale.  

I’m sure you won’t be surprised to note that the euro (-0.4%) has fallen further this morning amid a broad-based dollar rally, that German stocks (DAX -0.8%) are falling and German bund yields (-2bps) are also falling as it becomes ever clearer that the ECB is going to need to cut rates more aggressively than previously anticipated.  Perhaps the story of Bayer Chemical today, where their earnings fell 26% and the stock has fallen 11% to a level not seen since 2009, is a marker.  Just like Volkswagen, they are set to cut costs (i.e., fire people) further.  Germany is having a rough go, and if they continue to perform like this, Europe will have a hard time going forward.

So, while the media in the US continues to focus on President-elect Trump and his activities as he fills out his cabinet posts and other government roles, elsewhere around the world, governments are trying to figure out how to respond to the changes coming here.

In that vein, the COP 29 Climate Conference is currently ongoing in Baku, Azerbaijan (a major oil drilling city) but finding much less press than previous versions.  As well, the attendee list has shrunk, especially from governments around the world.  This appears to be another consequence of the shift in voting preferences.  In fact, I expect that over the next four years, the number of discussions on climate will decline substantially.  

Perhaps the best place to observe how things are changing is China, as they now find themselves in the crosshairs of Trump’s policy changes and they know it.  The question is how they will respond with their own policies.  Recall, last week there were great hopes that we would finally see that big bazooka of fiscal stimulus and it was never fired.  Recent surveys of analysts, while continuing to hope for that elusive stimulus, now see a greater chance of Xi allowing the CNY to decline more rapidly to offset the impacts of tariffs.  This is something that I have expressed for a long time, that the CNY will be the relief valve for the Chinese economy as it comes under pressure.  Certainly, the market seems to be on board with this thesis as evidenced by the CNY’s movement since the election.  I expect there is further to run here.

Source: tradingeconomics.com

Ok, between Germany and China, those were the big stories away from the Trump cabinet watch.  Let’s see how markets behaved overnight in the wake of yet another set of record high closings in the US yesterday.  Despite the yen’s weakness, the Nikkei (-0.4%) was under pressure, although nothing like the pressure seen in China (Hang Seng -2.8%, CSI 300 -1.1%) or even elsewhere in Asia (Korea -1.9%, India -1.0%, Taiwan -2.3%) with pretty much the entire region in the red.  Of course, the same is true in Europe with all the major bourses under pressure (CAC -1.3%, FTSE 100 -1.0%) alongside the DAX’s decline.  As to US futures, at this hour (7:15) they are essentially unchanged as we await a series of five more Fed speeches.

In the bond market, Treasury yields (+6bps) are rising as it appears the 4.30% level is acting as a trading floor now that we have seen moves above it.  However, as mentioned above, the weaker economic prospects in Europe have seen yields across the continent soften between -1bp and -2bps.  Futures markets are now pricing more rate cuts by the ECB over the next year than the Fed although both are pricing about the same probability of a cut in December.  I think the direction of travel is less Fed cutting and more ECB cutting and that will not help the euro.

In the commodity markets, the rout in the metals markets continues with both precious (Au -0.8%, Ag -1.0%) and industrial (Cu -2.0%, Al -0.8%) finding no love.  In fairness, these had all seen very substantial rallies since the beginning of the year, so much of this is profit-taking, although there are those who believe that Trump will be able to arrest the constant rise in US debt issuance.  I’m not so sure about that.  As to oil (+0.6%) it has found a temporary bottom for now, but I do expect that it will continue to see pressure lower.

Finally, the dollar is king today, higher against every one of its counterparts in both the G10 and EMG blocs.  In the G10, the movement is almost uniform with most currencies declining between -0.4% and -0.5% although CHF (-0.1%) is trying to hang on.  In the EMG bloc, there are some larger declines (ZAR -0.8%, CZK -0.9%, HUF -0.9%) while LATAM currencies are lower by -0.5% and we saw similar movements in Asia overnight, -0.5% declines or so.  Again, it is difficult to make a case, at least in the near term, for the dollar to decline very far.  Keep that in mind when considering your hedges.

On the data front, the NFIB Small Business Optimism Index was released earlier at a better than expected 93.7, roughly the same as the July reading and potentially heading back toward the 2022 levels obtained during the recovery from the covid shutdowns.  I expect the election results had some part in this move.  Otherwise, its Fed speakers and we wait for tomorrow’s CPI.  All signs continue to point to a positive view in the US and a stronger dollar going forward.  Parity in the euro is on the cards before long.

Good luck

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Fraught

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The job growth that everyone thought
Existed, seems like it was fraught
Meanwhile ISM
Showed further mayhem
As growth slowed while prices were hot
 
The funny thing was the reaction
Where stocks were a source of attraction
But at the same time
Bond buys were a crime
With sellers the ones gaining traction

 

The NFP data was certainly surprising as the headline number fell to its lowest level, 12K, since December 2020 with the worst part, arguably, the fact that government jobs rose 40K, so there were 52K private sector job losses.  That is just not a good look, nor were the revisions to the previous months which saw another 112K jobs reduced from the rolls.  It cannot be surprising that the Fed funds futures market immediately took the probability of a rate cut to 99% this week and raised the December probability to 82%, up more than 10 points in the past week.  After all, Chair Powell basically told us that he has slain inflation, and they are now hyper focused on the employment mandate.  With that in mind, the futures reaction makes perfect sense.

Perhaps even more surprising was the market reaction, or the dichotomy of market reactions, which saw equity markets in the US rally nicely, with gains between 0.4% and 0.8% in the major indices, while Treasury yields spiked 10bps despite the data.  That yield spike helped carry the dollar higher as the greenback rallied smartly against virtually all its counterparts by more than 0.50%, and it undermined commodity prices.  

The most common explanation here, though, had less to do with the NFP data and more to do with the recent polls regarding the US election, where it appeared the former president Trump was gaining an advantage.  Remember, the ‘Trump trade’ is being described as a steeper yield curve with benefits for the dollar and US equities on the back of stronger growth and higher inflation.

There once was a US election
Where both candidates lacked affection
The worry it seems
Is half the world’s dreams
Are likely soon met with dejection
 
Meanwhile for investors worldwide
This week ought to be quite a ride
To all our chagrins
No matter who wins
Look for either outcome denied

However, this morning, the markets have changed their collective mind, with virtually all of Friday’s movement now unwound, at least in the bond and FX markets.  What would have caused such a reversal?  Well, the latest polls show that the race is much tighter than thought on Friday, with VP Harris gaining ground in a number of them, which now has most pundits simply calling for their favored candidate to win, rather than trying to read the polls.  As such, the Trump trade has been partially unwound and my sense is that until there is an outcome, it will be difficult for markets to do more than increase the amplitude of their moves amid less and less actual trading.  At least, that is true in bonds, FX and commodities.  Stocks, as we all know, are legally mandated to rise every day, so are likely to continue to do so. 

And now, despite the fact that the Fed meets on Thursday, with a rate cut all but assured and ostensibly a great deal of interest in Chairman Powell’s press conference, all eyes are on the election.  Remember, too, not only is that the case in the US, but also around the world.  Whether friend or foe of the US, pretty much all 195 nations on the planet are invested in the outcome.

With that in mind, and since this poet has no deep insight into the outcome, let me simply recount the overnight market activity with the understanding that many trends have the opportunity to reverse depending on the results.

Starting with equity markets, Japanese shares (-2.6%) fell sharply as a combination of both their domestic political struggles (remember their government situation is unclear after the recent snap election) and the significant rebound in the yen (+0.9%) weighed on equities there.  India (-1.2%) also struggled but elsewhere in the time zone, stocks rallied nicely led by China (+1.4%) and Korea (+1.8%) as visions of that Chinese fiscal bazooka continue to dance in investors dreams.  Interestingly, the WSJ had an article this morning downplaying the idea, which based on their history makes a great deal of sense to me.  Turning to Europe, most markets there are firmer, albeit only modestly so, with gains from the CAC and IBEX (+0.3% each) outpacing the DAX (0.0%).  Finishing off, US futures are basically unchanged at this hour (7:00).

In the bond markets, while the Treasury move Friday did help drag European yields somewhat higher, it was nothing like seen in the US and this morning, those yields are essentially unchanged, +/- 1bp in most cases.  The only data of note was the final PMI data which confirmed the flash data from last week.  As to JGB yields, they have been stuck in the mud for a while now, still hanging below the 1.0% level with no designs of a large move.

Oil prices (+3.1%) are rebounding nicely on news that OPEC+ has delayed their previous plans to start increasing production as of December this year.  Concerns about oversupply in the global market plus the return of Libyan production and record high US production have convinced them they better leave things as they are.  Metals markets are a bit firmer this morning with gold (+0.2%) actually somewhat disappointing given the magnitude of the dollar’s decline, while both silver (+1.25%) and copper (+1.1%) show nice gains.

Finally, the dollar is under severe pressure across the board.  The biggest gainers are MXN (+1.2%), NOK (+1.2%) and PLN (+1.1%) although most gains are on the order of 0.7% or more.  Certainly, the oil story is helping NOK, and given the concerns that traders have about prospective tariff increases on Mexico if Trump wins, the idea that the race is closer than previously thought has supported the peso.  As to the zloty, it seems that their PMI data, printing at 49.2, a fourth consecutive rise) has traders looking for a more hawkish central bank on the back of stronger economic activity.

On the data front, aside from the election and the Fed, there is other information, although it is not clear that anyone will notice.

TodayFactory Orders-0.4%
TuesdayTrade Balance-$84.1B
 ISM Services53.8
ThursdayBOE Rate Decision4.75% (current 5.00%)
 Initial Claims223K
 Continuing Claims1865K
 Nonfarm Productivity2.5%
 Unit Labor Costs1.1%
 FOMC Rate Decision4.75% (current 5.0%)
FridayMichigan Sentiment71.0

Source: tradingeconomics.com

Of course, the election will dominate everything, and it certainly appears that there will be legal challenges from the losing side regardless of the outcome.  My expectation is that markets will remain jumpy with outsized moves on low volumes until there is more clarity.  It is not often that an FOMC meeting is seen as an afterthought, but much to Chairman Powell’s delight, I sense that is going to be the case this week.  

I have already voted early and I encourage each of you to vote as the more voices heard, the better the case the winner will have at achieving a mandate.  And the reality is, we need a president with a mandate if we are going to see broad-based positive changes in the nation going forward.

Good luck

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Still Weak

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In Germany, data’s still weak
For Europe, that doesn’t, well, speak
So, riddle me this
Are traders remiss
For claiming that euros are chic?
 
It’s true interest rates matter most
And Powell said Fed funds are toast
But can M. Lagarde
Just simply discard
The Germans, though they’re comatose?

 

There is a growing opinion that the dollar is going to decline sharply as the Fed begins to cut rates.  Numerous analysts believe that the market is underpricing how many Fed fund cuts are coming as they are all-in on the US recession story.  After Friday’s Jackson Hole speech, it certainly appears that we will get at least one cut come September, but stranger things have happened.  And obviously, given Powell’s pivot from inflation to unemployment as job #1, the NFP report a week from Friday is going to be crucial.

But we must never forget that the FX market is a relative concept.  It is not simply that one country’s economy is doing well or poorly, nor that their interest rates are high or low, or perhaps moving up or down, it is how those data points compare to other countries that determines the movement in the FX markets, at least the fundamentals, but also frequently the capital flows.  It is with this in mind that on a quiet day we have time to dissect the story in Germany for a bit.  Early this morning, Germany’s Federal Statistical Office released two data points, the GfK Consumer Confidence reading, which fell sharply to a below consensus reading of -22.0 and the Final GDP Growth numbers for Q2, which printed at -0.1% Q/Q and 0.0% Y/Y.  Now, this is not a single quarter feature in Germany as is illustrated in the below chart.

A graph with blue and yellow squares Description automatically generated

Source: tradingeconomics.com

In fact, GDP growth in Germany has averaged just 0.3% annually over the past 5 years, a pretty anemic level, and one that bodes ill for Europe as a whole.  Recall, Germany’s economy is the largest in Europe (and 3rdlargest in the world) and represents about 28.6% of the Eurozone’s total economy.  If the largest economy in a group of nations is stagnating, it is very difficult for the group’s overall growth rate to expand.  Compare that to the fact that the data to date in the US indicate that growth remains fairly solid (GDP +2.8% in Q2), and then ask yourself, where are the opportunities for activity more prevalent, Europe or the US?  Again, the macro picture seems to point to the US as a continued preferred destination for capital.

And yet, the euro is pushing back to its highest level since a brief spike in July 2023, and otherwise, early 2022 prior to that.  So, does it really make sense for the euro to continue to rally from here?  Literally, the only argument in its favor is that the Fed has now committed to begin easing policy and the market is pricing in about 200bps of rate cuts through the end of 2025.  Meanwhile, although the ECB has implemented their first rate cut, and seem set to execute their second next month, the market is only pricing in 125bps of cuts by December 2025, and just 50bps total for 2024, compared to 100bps for the Fed.

As such, here is the explanation for the euro’s recent solid performance.  But I believe the question to ask is, can this last?  If Germany’s economy is going to continue to bounce along at essentially zero growth, and there is nothing indicating a rebound is coming soon, it seems more likely to me that the rest of Europe follows it lower, rather than ignores Germany and powers ahead.  It’s not that individual small nations in the Eurozone won’t grow more quickly, but Germany’s position in the Eurozone, notably as a trade partner, implies that things are more likely to sag than soar.  

Yes, the euro has rebounded lately, but that has been in response to the interest rate pricing described above.  I think it is a fair bet that Madame Lagarde, when faced with a Eurozone that is growing more slowly than desired, is likely to accelerate interest rate cuts there.  And when that happens, the euro’s recent rise will very likely retrace.  I am not saying that the dollar is going to climb against everything, just that the euro’s strength feels suspect.  One poet’s view.

I’m sorry for the focus on Germany, but some days, there is very little macro news of note, and this seemed the most important, especially given that the idea of a much weaker dollar going forward is gaining traction.  

Ok, with that in mind, let’s look at the overnight activity, which was not all that substantial.  After yesterday’s split between tech shares (NASDAQ -0.85%) and industrials (DJIA +0.16% and a new ATH), Asian shares were mixed as well.  The Nikkei (+0.5%) had a solid session as did the Hang Seng (+0.4%) although mainland Chinese shares (-0.6%) continue to suffer, last night due to a much weaker than forecast earnings result from the parent company of Temu.  Of more concern than the result was the commentary by their CEO that prospects for consumption were dimming.  In Europe, there are some very modest gains, with the DAX (+0.2%) surprisingly holding up well, although the move is obviously quite minimal.  I cannot look at the Eurozone economy and expect anything other than more aggressive rate cuts from the ECB going forward.  As to US futures, at this hour (7:30), they are essentially flat.

In the bond market, yields are backing up from their recent lows with Treasuries higher by 3bps and European sovereigns by between 5bps and 7bps.  In fact, the real outlier is the UK gilt market where 10yr yields are higher by 9bps as there is an increasing concern that the Starmer government is going to blow up the budget there as the PM tries to implement his new policies.  You may remember what happened when Liz Truss was PM and proposed a high spending, high deficit budget and caused all kinds of havoc in the gilt market back in October 2022.  I would not rule out another situation like that quite frankly.  Finally, JGB yields edged lower by 1bp last night, continuing to prove that normal monetary policy in Japan remains a distant prospect.

In the commodity markets, oil (-0.4%) which is higher by > 5% in the past week, has stopped climbing for now.  Perhaps the fact that there have been no new military incursions in the Middle East has been sufficient to get the algos to start selling again on the poor demand story.  Gold (-0.2%) is also biding its time, as are the other metals, although all are retaining the bulk of their recent gains.  Generically, my dollar view is that it will weaken vs. stuff like commodities, not necessarily vs. other currencies.  Of course, this implies a rebound in inflation, something which I continue to see going forward.

Lastly, the dollar is little changed this morning, with most G10 and EMG currencies +/-0.2% or less compared to yesterday’s closing levels.  The biggest mover today is NZD (+0.4%), although I am hard-pressed to see any fundamental reason as there was neither data nor central bank commentary.  Arguably, this is the result of some position changes rather than a fundamental move.  And after that, nothing has moved much at all.

Yesterday’s Durable Goods print of +9.9% was astonishingly high, although the ex-transport reading of -0.2% was a tick lower than forecast.  I guess Boeing sold more planes than anticipated.  As to this morning, we see Case-Shiller Home Prices (exp 6.0%) and Consumer Confidence (100.7), neither of which seems likely to have a major impact.  SF Fed president Daly reiterated the Powell idea that the time has come to cut rates, and I expect every Fed speaker going forward up to the quiet period to say the same.  I guess the real problem will be if the NFP report is hot.  Right now, the early forecasts are for 100K NFP and the Unemployment Rate to remain unchanged at 4.3%.  But what if it prints at 200K and Unemployment slips back a tick?  Will they still be anxious to cut?  I’m not forecasting that, simply reminding us all that assumptions need to be tempered.

As it is the last week of August with holidays rife around the Street, I suspect it will be very quiet overall.  At this point, we need more data to make decisions, so look for limited activity in the FX markets, although I guess the world is really waiting for Nvidia’s earnings tomorrow more than anything else.

Good luck

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The Mantra Repeated

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Inflation has now been defeated
At least that’s the mantra repeated
By equity bulls
Who’re buying bagfuls
Of stocks which last week had depleted
 
But what if the data today
Does not show inflation’s at bay?
Will pundits still call
For Fed funds to fall
Or will cooler heads get their way?

 

As last week fades into the mists of memory, the narrative writers have been hard at work reimposing the soft-landing thesis and how the Fed is going to ride to the rescue of what seems to be slackening data across most aspects of the economy. The latest piece of information was yesterday’s PPI numbers that indicated, at the producer level, price pressures were ebbing further.  In fact, the core PPI reading for July was 0.0%, a huge victory for the Fed as it continues to add to the story that their timely behavior and strength of will have been having the desired effects.  And maybe they have been doing just that, although there is reason to believe that other things are happening.

Regardless, with the much more important CPI data set to be released this morning, if those PPI numbers are “confirmed” with lower than forecast CPI numbers, there will be no stopping the equity rebound/rally and expectations for a 50bp cut at the September meeting will run rampant.  The current median forecasts, according to tradingeconomics.com are: 

  • Headline (0.2%, 3.0% Y/Y); and 
  • Core (0.2% (3.2% Y/Y).  

Almost by definition, at least half of the punditry is looking for a headline print with a 2 handle, substantially closer to the Fed’s target than we have seen since March 2021.  The basis of this view is that shelter costs are going to continue to trend lower and there is a growing expectation that used car prices are also destined to head lower.  Given the way that shelter costs are implemented in the CPI calculations, I have no opinion on how recent activity will impact the overall results.  However, the anecdata that comes from my neighborhood shows that homes continue to sell over asking prices in short order and that there is no sign of prices declining yet.  I know that what happens here is not necessarily occurring elsewhere in the country, but it is unlikely to be entirely unique.  I guess we’ll all see the answer at 8:30.

In the meantime, the market story has been twofold, equity bulls are basking in the glow of the rebound from last week’s dramatic declines and the interest rate doves are completely willing to ignore actual Fed commentary and are increasing their bets that the Fed starts this cutting cycle with a 50bp reduction.  

As can be seen in the graphic below from the cmegroup.com website, the 50bp cut story is slightly more than a coin flip at the moment.  

A screenshot of a computer Description automatically generated

But the interesting thing is to see how this pricing has evolved over the past month.  Looking at the table at the bottom of the graphic shows that last week, in the wake of the Japanese market selloff, the belief was much stronger that a 50bp cut was on the way (in fact, on July 5th, that probability was >90%), but a month ago, it was a very low probability event.  Back then, it was only the true believers in an upcoming recession that were looking for 50bps.  But now, it is mainstream thinking, at least among the punditry.  Yesterday, Atlanta Fed president Raphael Bostic explained, “we want to be absolutely sure.  It would be really bad if we started cutting rates and then had to turn around and raise them again.”  However, he did acknowledge that he is likely to be ready to cut “by the end of the year.”  While I have never met Mr Bostic, this does not sound like a man who is desperate to cut interest rates soon, narrative be damned.

Ok, away from all the huffing and puffing on US CPI, we did get some other important news overnight.  The first thing was the RBNZ surprised many folks by cutting their Official Cash Rate by 25bps.  Apparently, they are concerned with slowing growth and gratified that inflation appears to be slowing.  The upshot was that the NZD (-1.0%) fell sharply and the local stock market rallied more than 2%.

Elsewhere, UK inflation was released at a lower than expected 2.2% for July.  While that was an uptick from the June level of 2.0%, the fact that it was lower than both the BOE and Street expectations, and that services inflation rose “only” 5.2%, down from the 5.7% reading in June, has traders increasing their bets for a rate cut in September.  The pound (-0.2%) did slip slightly on the report but remains modestly higher on the year.  As to the FTSE 100, its 0.3% gain pales in comparison to the type of movements we have been seeing in equity markets elsewhere.

The zephyrs of change
Are blowing throughout Japan
Kishida’s leaving

One last piece of news is that Japanese PM, Fumio Kishida, has announced that he will not be running for LDP party leadership, the critical post to become (or in his case remain) Prime Minister.  A series of fundraising scandals has dogged his entire administration, and his approval rating remains below 30%.  The market take is that his leaving will enable the BOJ to act more aggressively, at least according to some local analysts and all depending on who wins the election.  While several of the mooted candidates are on record as calling for more monetary policy normalization (i.e. rate hikes), they are not the leading candidates at this time.  It seems early to make that case in my mind.  In the meantime, while the BOJ may want to raise rates, I think they are going to wait for more rate cutting in the rest of the G10, specifically from the Fed, before considering their next move.  Net, the yen’s response to this story has been nil, although we did see Japanese equities rally (Nikkei + 0.6%).

Elsewhere in equity markets, both the Hang Seng (-0.35%) and CSI 300 (-0.75%) continue to languish relative to other markets around the world as the prospects for the Chinese economy, and by extension its companies, remains lackluster, at best.  The absence of any significant Chinese stimulus remains a weight on the economy and the markets there.  However, most other markets in Asia rallied nicely overnight, following the US price action yesterday.  As to European bourses, they are all green, but the movements have been modest, on the order of 0.3% or so, as Eurozone economic data continues to disappoint (IP -0.1% in June, exp +0.5%).  As to US futures, ahead of the CPI data, they are essentially unchanged.

In the bond market, Treasury yields continue to grind lower, falling 7bps after the PPI data yesterday and down another basis point ahead of the CPI today.  European sovereign yields, though, are slightly higher this morning, between 1bp and 2bps, which based on the data makes no sense.  But the moves are small enough to be irrelevant.  One outlier here is UK Gilt yields, which have declined 4bps on the softer inflation print.

Oil (-0.2%) which suffered yesterday has stopped falling for the moment as the market remains on tenterhooks regarding a possible Iranian attack on Israel.  In the meantime, expectations are for a further draw of oil inventories in the US, although the industry continues to pump an extraordinary 13.4 million bpd despite all the efforts of the current administration to stifle it.  As to the metals markets, gold (+0.4%) continues to find support and is pushing toward new highs yet again.  This morning it is taking the rest of the metals complex with it, although that could be a result of the dollar’s modest weakness.

Finally, the dollar is a bit softer overall this morning, but there are several idiosyncratic stories.  We’ve already mentioned NZD, GBP and JPY.  However, the euro (+0.25%) is now at its highest level of 2024 and back above 1.10.  Meanwhile, the commodity currencies are mostly firmer vs. the dollar this morning (ZAR +0.3%, MXN +0.3%, NOK +0.6%, SEK +0.5%) although Aussie (-0.2%) is bucking that trend.  One other noteworthy mover is CNY (+0.2%) which has been showing far more volatility than normal in the past two weeks.  It seems it is still coming to grips with the Japanese story as well.

And that’s really it for the day.  There are no Fed speakers on the calendar, but we must always be aware of some unscheduled interview.  Remember, they love to talk.  Right now, I would say the market is looking for softer inflation data and is pricing accordingly.  As such, if this data is even modestly warm, let alone hot, be ready for some quick reversals, at least early in the session.  So, stocks lower with bonds while the dollar climbs.  But based on the current zeitgeist, I have to believe that any dip will be bought with reckless abandon.

Good luck

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Kind of a Mess

Posted on by

The narrative which had been forming
Was prices were constantly warming
While job growth was strong
The bears were all wrong
And buyers of stocks were now swarming
 
But Friday the data was less
Impressive, and kind of a mess
At first, NFP
Was weak, all agree
Then ISM caused more distress

 

It is remarkable how quickly a narrative can change, that’s all I can say!  One week ago, the story was all about how the economy continued to perform well overall, that inflation remained sticky at levels higher than targeted and that the Fed would stick with higher for longer with a chance of a rate hike on the table.  This morning, in the wake of a clearly dovish Powell press conference and softer than expected ISM and employment data, the narrative appears to be coalescing around the idea that cuts are back on the table while a recession can no longer be ruled out.

The table below, courtesy of the Chicago Mercantile Exchange, shows the current probabilities for Fed funds based on futures pricing for the December 2024 contract as well as how they have evolved over the past week and month.

Source: CME

When calculating how much is priced into the market, one simply multiplies the size of the cut by its stated probability and voila, the answer appears.  To save you the trouble of doing the math, the current market pricing shows that as of this morning, the market is pricing in 47.6bps of cuts by year-end, so essentially two cuts.  One week ago, that number was 34.8bps while one month ago it was 65.7bps.  in other words, we have seen a bit of movement in this sentiment indicator.  And really, that’s exactly what this is, a measure of the market’s sentiment and expectations of how Fed funds are going to evolve over time.  

What should we make of this information?  Well, anecdotally, for the past several weeks I have not been reading about recession at all.  The no-landing scenario seemed to be the favorite as the soft-landing idea ebbed amid too high inflation readings.  But this morning, in concert with the Fed funds futures market, I have seen several stories discussing that a recession is on the horizon now and coming into view.  The ISM data was clearly a problem as both the Manufacturing (49.2) and Services (49.4) numbers slipped below the 50.0 boom/bust line while the Chicago PMI release was abysmal at 37.9.  Even worse, the Prices paid data for both Manufacturing (60.9) and Services (59.2) rose sharply, exactly what Chair Powell did not want to see.  In fact, this data rhymes with the Q1 GDP data which showed the mix of activity was turning toward less growth (1.6%) and more inflation (3.7%) for a given amount of activity.

Now, Powell was very clear that he saw neither the ‘stag’ nor the ‘flation’ sides of the idea that the US was slipping into stagflation, and certainly compared to the situation in the 1970’s, we are nowhere near that type of situation.  But there is a bit of whistling past the graveyard here, I believe, as slowing real growth and rising prices are not the combination that any central bank wants to have to fight.  When Mr Volcker took over the role as Fed Chair in 1979, he pretty quickly decided that it was more important to fight inflation first, and deal with any recession later, hence the double-dip recessions of 1980 and 1982.  But that set the stage for structurally lower interest rates for two generations.

Based on Powell’s press conference comments as well as the tone of many of the mainstream media stories that are currently in print regarding the economic situation, it appears to this poet as though Mr Powell may be far more willing to allow inflation to run hotter than target for longer as he tries to prevent a sharp recession, especially ahead of the presidential election.  With rate hikes no longer an option, any semblance of higher inflation will be met with words alone, and that will not do the trick.  I have maintained for a long time that if the Fed eased policy before inflation was squashed, it would be bad for bonds, bad for the dollar and good for commodities and stocks.  I am now coming to believe that we are entering this environment, and that while the initial move in bonds may be higher (lower yields) as it becomes clear that inflation remains with us, bond investors will quickly decide that the risk/reward in an inflationary environment is quite poor, and we will see the back end of the curve sell off.

After those cheery thoughts for a Monday morning, let’s look at how markets have behaved overnight.  Friday’s rip-roaring rally in the US was mostly followed by strength throughout Asia where markets were open (Japan and South Korea were closed) with China, Hong Kong, Australia, and Taiwan all having good sessions, up between 0.75% and 1.25%.  It should also be no surprise that European bourses are all in the green this morning as rate pressures eased and adding to the happiness were PMI Services reports that were generally on target or slightly better than the flash numbers.  In other words, all is right with the world!  Finally, US futures are also firmer by a bit this morning, up 0.2% or so with the main talk still about Apple’s massive stock repurchase program as well as the Berkshire Hathaway AGM this past weekend.

Of course, bonds were the big mover on Friday, with yields plummeting in the wake of the softer than expected NFP data, where not only were claims lower, but so was earnings data and the Unemployment Rate ticked up to 3.9%.  The initial move was a 9bp decline in the 10yr and and 10bps in the 2yr although by Friday’s close, both markets had retraced half of those declines.  This morning, though, yields are sliding again with 10yr Treasuries down 3bps and all European sovereigns following suit, falling 4bps.  (As an aside, on Friday, the European yields followed Treasuries tick for tick.). With Japan closed, there was no JGB movement overnight.

In the commodity markets, crude oil (+1.0%) is bouncing today from yet another weak performance on Friday as the weaker economic data is weighing on the demand story there.  However, regarding geopolitics and the middle east, this morning’s headlines regarding Israel telling Palestinians to leave Rafah has the market on edge.  But metals markets are back on fire this morning with both precious (Au +0.7%, Ag +2.1%) and industrial (Cu +2.0%, Al +1.1%) rallying on the lower interest rate, higher inflation story that is percolating through markets.

Finally, the dollar, too, is under pressure this morning continuing its trend from last week, although it is not collapsing by any stretch with the DXY still trading just above 105.00.  There is a great deal of discussion as to whether the BOJ/MOF have been successful in their efforts to stem the yen’s decline permanently.  It is clear that their two bouts of intervention (neither officially admitted) has done a good job in the short run.  The story here, though, is all about interest rates.  If, and this is a big if, the Fed is truly turning their sights on cutting rates with any help at all from inflation showing signs of ebbing again, then the higher dollar thesis is going to run into real trouble.  I have made no bones about the idea that the dollar’s strength was entirely reliant on the fact that the Fed was the most hawkish of all the main central banks.  If that is no longer the case, then the dollar is going to come under universal pressure and the yen probably has the most to recover.

**This is really critical for JPY asset and receivables hedgers.  There is no better time to consider using purchased options or zero premium collars than right now.  If the recent movement is a head fake, and the inflation story in the US grows such that the Fed puts hikes back on the table, then you will have put hedges in place.  But…if this is the beginning of a truly new narrative, where US rates are going to decline, USDJPY can fall a very long way in a very short time.  Look at the 5-year chart of USDJPY below.  It was in 2022 when USDJPY was trading at 115 and that had been the level for several years.  we can go back there in a hurry, believe me!**

Source: tradingeconomics.com

As to the rest of the currencies out there, you will not be surprised that ZAR (+0.5%) is top of the heap this morning although a thought must be given to CLP’s 2.25% gain on Friday (market not open yet) as it rallied alongside copper’s rally.  Ironically, the one currency that is under pressure this morning is JPY (-0.5%), but remember, it has risen 4% from the levels when the BOJ first intervened, so a little bounce is no surprise.

Turning to the data this week, it is an incredibly light week, with CPI not coming until next week.

TuesdayConsumer Credit$15B
ThursdayInitial Claims212K
 Continuing Claims1895K
FridayMichigan Sentiment77.0
Source: tradingeconomics.com

As well, we have eight Fed speakers including NY president Williams and vice-Chair Jefferson.  It will be very interesting to hear how they play the apparent pivot.  While I expect that the governors are all on board, the regional presidents will have more leeway to speak their mind I believe.

And that’s what we have for today.  I believe that things have changed and that the Fed is now very clearly far more willing to allow inflation to run hotter.  Be very wary of your bond positions and watch for the dollar to remain under pressure until something else changes.

Good luck

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Wronger

Posted on by

The data was, once again, stronger
Reminding us higher for longer
Is still on the cards
Despite the diehards’
Beliefs that Chair Powell is wronger

As well, from two speakers we heard
And none of their signals were blurred
Said Daly and Mester
To every investor
All rate cuts are likely deferred

First, our thoughts are with the people of Taiwan which suffered a massive earthquake last night registering 7.4 on the Richter Scale.  The damage was substantial and while the early count of fatalities is relatively low, just seven so far, I fear there will be more.  From a business perspective, roads and rail lines were damaged and some of the semiconductor fabs were taken offline. The last issue matters greatly as it has the potential to drive up costs and thus prices of finished goods even further (remember what happened to auto prices during Covid when there was no availability of chips?).  It is still too early to determine what the ultimate impacts will be, but the risk is that this will add to inflationary pressures if anything.

However, away from that news, the market story from yesterday and overnight is that the data continues to point to stronger growth in the US (Factory Orders jumped 1.4%) and the latest Fed speakers we heard, Daly and Mester, explained that while three cuts are still possible this year, neither one yet has the confidence that inflation is truly heading back to their 2% goal.

And this is really the entire story for now.  It remains abundantly clear that the Fed is very keen to cut interest rates.  Their macroeconomic backgrounds look at all that has happened and given their underlying belief that the “proper” long-term interest rate is somewhere between 2.5% and 3.0%, they are concerned their current policy is too tight.  And yet, despite these views, virtually every data point that is released shows solid economic activity and no hint that things are slowing down, especially in the labor market.

So, despite that strong desire, they are wary of acting because they know, or at least Powell knows, that if they cut and inflation resurges, it is all on him.  Remember, Powell has made it clear multiple times that he wants to be Paul Volcker redux, not Arthur Burns redux.  The Fed funds futures market continues to price just 66bps of cuts by the December meeting, a telling statement about the difference between market beliefs and Fedspeak, at least yesterday’s Fedspeak.  Granted, we heard last week from two Fed speakers who thought either one or two cuts was the most likely outcome.

Today brings five more speakers including Chair Powell as well as both ADP Employment (exp 148K) and ISM Services (52.7), so there is ample opportunity for news to shake things up.  Based on everything we have seen regarding the US economic data; it seems the risks are for hotter data rather than softer data.  But of more importance, I believe, will be Powell’s comments.  If he accepts the idea that the economy continues to run fairly well with the current interest rate structure and says anything about less than three cuts being appropriate, watch out!

So, let’s look at what happened in markets overnight.  After a weak session in the US yesterday on the growing concern that monetary policy is going to remain tighter, Asia followed suit with declines across the sector.  The Nikkei (-1.0%) and Hang Seng (-1.2%) were both feeling the weight of this evolving narrative.  Surprisingly, mainland Chinese shares were also under pressure despite continued talk of more fiscal stimulus as well as a resurfacing of the idea that President Xi is willing to countenance some version of QE there.  It should be no surprise that virtually every regional market was in the red.

European bourses, though, are a different story this morning as they are higher after the initial read for Eurozone inflation fell to 2.4%, two ticks lower than expected while the Core reading fell to 2.9%, one tick lower than expected and the lowest since February 2022.  Equity investors saw this and decided that the ECB has far fewer impediments to cutting rates than the Fed.  In fact, the only market not behaving like this is the FTSE 100, which received no such news and is somewhat softer this morning.  As to US futures, they are essentially unchanged ahead of Powell’s speech today.

In the bond market, this dichotomy of policy views is also evident as Treasury yields continue to climb, edging up another basis point this morning while European sovereign yields are mostly lower, between 2bps (Spain) and 4bps (Germany) with one outlier, Italy (+2bps).  The Italian situation has to do with the European commission putting pressure on the nation regarding its budget situation which may fall afoul of the current regulations.

In the commodity markets, oil (+0.45%) continues to trade higher as the tensions in the Middle East show no sign of abating while Ukraine has been successful in interrupting Russian refinery production to some extent. Meanwhile. OPEC meets today and there is no indication that they will be changing their production restrictions.  Gold (-0.4%) which has been flying, is taking a breather today although the other metals continue to grind higher.  Nothing has really changed this story as the industrial metals continue to respond to brighter economic prospects while the precious sector continues to worry about the ultimate debasement of the fiat world.

Finally, in that fiat world, the picture is mixed this morning, although the best description is probably unchanged.  I’m hard pressed to look at my screen and see any exchange rate that is more than 0.1% different than yesterday’s levels.  Just like in the equity market, I believe traders are awaiting Chairman Powell’s comments today before taking any new positions.  Over the course of the past three weeks, the dollar has been quite strong, rallying about 3% on a DXY basis.  If the Fed continues to highlight that it is too soon to ease policy, and with today’s Eurozone inflation data, we start to hear more from ECB officials about the ability to cut, my sense is that we could see further strength in the greenback.

Overall, almost everything in markets continues to rely on Powell and the Fed.  Remember, Friday we will see the March payroll report.  If it continues the recent trend of >200K new jobs, it will be very difficult for any doves at the Fed to make their case effectively.  That could begin to weigh more heavily on the equity market but should support the dollar going forward.  Let’s listen to Chairman Jay today for our next clues.

Good luck
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Dismay

Posted on by

The data continues to show
The US is able to grow
If this is the case
Seems foolish to chase
The idea rate cuts are a go
 
Instead, I expect Powell’s way
Is higher for longer will stay
If rates, thus, stay high
Can risk assets fly?
Or will those high rates cause dismay?

 

The case for the Fed to cut rates continues to fade as not only have Powell and his team been cautioning patience, the data continue to show that economic activity is not slowing down.  The latest exhibit comes from yesterday’s ISM Manufacturing data which printed at a much better-than-expected 50.3, its first print above 50 in 16 months.  Not only that, but the New Orders and Prices Paid sub-indices both printed much higher than last month indicating business is picking up and so are prices.  Certainly, the chart below from tradingeconomics.com indicates that a clear trend is forming for better growth ahead.

The Prices Paid chart looks almost identical.  It strikes me that the recession call continues to get harder to make.  Certainly, things can change, but as of right now, I cannot look at the menu of data and conclude growth is set to slow rapidly.  Given this as background, it becomes increasingly difficult to make the case that the Fed is going to cut rates at all, at least based on the data.  This is a big problem for Powell if he remains insistent on making those cuts because it will call into question the rationale and really push the politics front and center.

As it happens, I am not the only one concluding that rate cuts are less likely, the CME’s Fed funds futures contract is slowly pricing cuts out of the mix as well.  This morning not only has the probability of a June cut fallen slightly to 58.8%, but the market is now pricing in just 66bps of cuts by the December meeting, less than the three full 25bp moves that the median dot indicated.  There is a ton of Fedspeak this week, starting with 4 speeches today from Bowman, Williams Mester, and Daly.  Chairman Powell speaks tomorrow and there are a dozen more after that, so it will be very interesting to see if the tone has changed to even more caution and patience.  With this as a backdrop, perhaps longer duration assets, like bonds and high growth companies (i.e., tech) could well feel some pressure.  We shall see how things play out.

Cooperation
Is not what the market gives
Instead look for pain

 

While the US story continues to be about stronger economic activity and a reduced probability of lower rates, in Japan, the story remains entirely focused on the yen’s weakness and whether the MOF/BOJ are going to respond.  First, remember that in Japan, like here in the US, the MOF is responsible for the currency, not the BOJ, meaning any intervention is directed by the MOF although it is executed by the BOJ.  This is why we need to focus on the FinMin and his minions regarding any actions.  In this vein, last night as USDJPY once again approached 152.00, FinMin Suzuki was back in front of reporters explaining, “Language aside, we’re now watching markets with a strong sense of urgency.  We are carefully watching daily market moves.”  He added, “All we can say is that we will take appropriate action against excessive volatility, without ruling out any options.”  

So, the MOF continues to threaten intervention with their urgent watching of markets (I feel like that is a very poor translation of whatever he is actually saying, although I suppose it gets the message across.). In one way, it was surprising they didn’t take advantage of illiquid markets yesterday to push the dollar lower as every dollar spent would have been far more effective, but a look at the recent price activity shows that while the yen has weakened appreciably since the beginning of the year, thus far their words have been sufficient to prevent further damage as the currency hasn’t budged in two weeks.  

The problem they have is that the US seems less and less likely to begin easing monetary policy and so the underlying fundamental driver of the exchange rate, interest rate differentials, is going to continue to weigh on the yen (and every other currency).  I also see no reason for Secretary Yellen to consider that a weaker dollar is a help for the US right now, so concerted intervention, a redux of the Plaza Accord of 1985 seems highly unlikely.  While at some point I do expect the MOF to act on their own, as is always the case, it will only have a short-lived impact on markets and likely be used as an entry point for speculators to extend their short yen trade.  The only solution is a change in policies and the BOJ blew that last month.

Ok, now that markets are back open again, let’s see what’s happening.  In Asia, the big mover was the Hang Seng (+2.35%) which was catching up to the news that China seemed ready to implement further stimulus that we heard on Friday.  But there was no consistency throughout the rest of Asia with both gainers and losers around the continent.  Europe is a similar mixed bag, with some markets higher and others lower despite what I would characterize as mildly better than expected PMI data released this morning across the entire continent.  While it wasn’t showing growth, the data improved on the flash numbers of last week.  US futures, however, are softer this morning by about -0.5% after yesterday’s lackluster session.  Certainly, continued hopes for rate cuts are diminishing and that seems to be weighing on stocks at least a bit.

In the bond market, yesterday’s US data set the tone as Treasury yields jumped 12bps yesterday after the strong ISM data and are up another 5bps this morning.  This has dragged European yields higher across the board with gains between 9bps (Germany) and 14bps (Italy).  Of course, the mildly better PMI data in Europe is adding to that mix.  Even JGB yields managed to edge higher by 1bp overnight, although they remain below 0.75%.

Oil prices have been flying, up another 1.1% this morning and now nearly 9% in the past month.  It seems that the escalation of events in the Middle East is having an impact at the same time that OPEC+ is holding firm on their production cuts.  There are rumors of some big Middle East settlement deal to end the war as well as get Saudi Arabia to recognize Israel, but the market does not yet believe that, clearly.  Considering that growth is making a comeback, that China seems ready to stimulate further and that production is not growing, it seems there is a pretty good chance that oil prices continue to rally.  Meanwhile, metals remain the flavor of the day with gold (+0.3%), silver (+1.7%), copper (+0.6%) and aluminum (+1.6%) all in demand.  The industrial metals are responding to the growth story, while the precious set are simply on a roll with fears that fiat currencies are going to continue to be debased top of mind.

Speaking of fiat currencies, the dollar, which rallied nicely over the long weekend, is settling back a bit this morning, but with no consistency.  For instance, CHF (-0.5%) is lagging sharply while NOK (+0.5%) and SEK (+0.5%) are both powering ahead.  The rest of the G10 is modestly firmer, but the movements are within 10bps of yesterday’s closing levels.  In the EMG bloc, ZAR (+0.5%) continues to benefit from the metals rally while PLN (-0.4%) is under pressure after its PMI data disappointed relative to its peers.  My view continues to be that as long as the Fed remains the most hawkish central bank, the dollar will find support.

On the data front today we see JOLTS Job Openings (exp 8.75M) and Factory Orders (1.0%) and we have all those Fed speakers mentioned above.  German CPI fell to 2.2%, as expected, which implies to me that the chances remain greater the ECB will cut before the Fed.  And that is really the big question now, which major central bank acts first.  With all the Fed speakers on this week’s docket, I suspect by Friday we will have a much better idea as to whether a June cut is still on the table.  We will be watching closely.

Good luck

Adf

A Narrative Flaw

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At first it was just CPI
With heat like the fourth of July
But Friday we saw
A narrative flaw
As PPI jumped, oh so high
 
The narrative’s now in a bind
While working so hard to remind
Investors that prices
Are not in a crisis
And Goldilocks can’t be maligned

 

It must be very difficult to be a cheerleader for the immaculate disinflation* these days given we continue to see data showing inflation is no longer receding.  Friday’s PPI was the latest chink in the deflationists’ armor as both the headline and core numbers printed well above expectations.  Of course, this followed Tuesday’s hot CPI prints as well as some lesser data like the prices paid portion of the NFIB survey and the last ISM Services survey.  Energy prices, which had fallen throughout Q4 but have since bottomed and appear to be trending higher again, are no longer a cap on inflation.  But of greater consequence is the fact that services inflation remains higher on the back of continued wage gains and rises in the price of things like insurance.  

Market participants are slowly coming around to the idea that the Fed may not be cutting rates quite like they were hoping for praying for anticipating just a few weeks ago.  This has been made clear by a quick look at the Fed funds futures market in Chicago which is now pricing in just a 10% chance of a March cut, a 35% chance of a May cut and a 75% chance of a June cut.  In fact, the market is now pricing in barely more than the Fed’s last dot plot for 2024, just 81bps for the entire year.

Of course, there is one benefit to the recent data and that is we stopped hearing about the 3-month trend and the 6-month trend showing the Fed had reached their target and so should be cutting rates NOW!  Instead, the fact that those trends are now pointing higher insures that we won’t hear about that for quite a while…I hope.

Philosophically, I remain confused as to why there is so much ‘demand’ that the Fed cuts rates at all.  While I certainly understand why the administration would like to see it, given the budget deficits that need to be financed, arguably, if nominal GDP growth is between 6% and 7% and Fed funds are at 5.5%, things don’t seem out of place.  If anything is out of place it is the 10-year yield, which even after rising 6bps on Friday, remains at 4.30%.  Historically, a more normal level of 10-year yields would be the same as nominal GDP growth.  Currently, that tells me either 10-year yields have much further to rise, or GDP is going to fall A LOT.  I sure hope it is the former.

Now, looking past Friday’s activity, this morning has been extremely quiet overall with the prospects for action looking quite limited.  Today the US celebrates President’s Day, so banks are closed as is the stock market, although futures markets are trading.  Canada is also mostly on holiday which implies that once Europe goes home, things will really die out.

But quiet is the best description of everything overnight.  One surprise was that Chinese equity markets were far less bullish than many anticipated as they reopened after the extended Lunar New Year holiday.  While the CSI 300 managed to rise 1.2% on the session, the bulk of the move came at the close with a wave of buying by their plunge protection team.  The disappointment was based on the stories that holiday travel had risen substantially which had been pumping up the Hang Seng which reopened last Thursday.  Alas, that market fell -1.1%, a perfect encapsulation of the overall disappointment.  In the meantime, European bourses are trading either side of unchanged and at this hour (7:00), US futures are doing the same, basically unchanged on the day.

Basically unchanged is an excellent description of the bond markets as well, with virtually every major European sovereign market either unchanged or higher by 1bp this morning.  Overseas trading of Treasuries has also seen limited activity and no yield change, and you will not be surprised to learn that JGB yields were also unchanged.  

In the commodity space, oil, which had a solid week last week and now shows WTI at ~$79.00/bbl, is a touch softer this morning, but only just.  I have seen a number of stories about peak oil having been reached again, but as you may know, I am no longer convinced that is the case.  Of course, that is a very long-term discussion which will have nothing to do with the daily fluctuations.  And shocks to the system can have a big impact regardless of the long-term story.  In the metals markets, gold is edging higher again, +0.3%, but both copper and aluminum are softer this morning by about -0.4%.  As with every other market, there is a lot of conflicting data that has been preventing a more coherent directional view here.  I suspect that will resolve over time, but in commodities, over time can mean months or years.

Finally, the dollar is little changed net with a mixture of gainers and losers.  For instance, in the G10, we are seeing very modest strength in NZD (+0.25%) and JPY (+0.2%, and just below 150.00 as I type), while in the EMG space there is some weakness as evidenced by ZAR (-0.4%) and KRW (-0.3%).  As with all markets today, I don’t think we are going to learn very much new.

As it is a holiday, there is no data today and, in truth, there is very little to be released all week.

TuesdayLeading indicators-0.3%
WednesdayFOMC Minutes 
ThursdayChicago Fed National Activity-0.19
 Initial Claims217K
 Continuing Claims1900K
 Flash Manufacturing PMI50.2
 Flash Services PMI52.0
 Existing Home Sales3.97M
source: tradingeconomics.com

In addition to that short slate, we hear from seven different Fed speakers including Governor Waller who seems to be the most important voice after Powell and Williams.  As it happens, five of those come Thursday with Waller the last at 7:30 that evening.

For today, I would not expect much at all in the way of market movement.  Given the lack of obvious catalysts, a quiet week seems likely as well.  Perhaps the biggest news is NVDIA is releasing their earnings Wednesday after the close, although from an FX perspective, that doesn’t seem crucial.  Big picture tells me that the Fed is not going to be easing policy soon, and that as long as the US economy continues to outperform those of Europe, Japan, the UK and China, the dollar is likely to find continued support.  Realistically, I think you could make the case for the dollar to rally substantially over the course of the year, but right now, that doesn’t feel like the move.

Good luck

Adf

*Immaculate disinflation – the idea that inflation can decline without a slowdown in growth or recession, but rather because it’s previous rise was transitory, just taking a little longer than originally anticipated.