Tag Archives: #FOMC

Bulls’ Fondest Dreams

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While everyone focused on Jay
The earlier news of the day
Showed Janet would not
The long bond, allot,
Too much, thus yields faded away

Combining that news with the Fed
And all of the things that Jay said
It certainly seems
The bulls’ fondest dreams
Are likely to still be ahead

While most of the headlines yesterday afternoon and this morning revolve around the FOMC meeting and, more importantly, Powell’s press conference, I would argue that as I discussed yesterday, the biggest story was the QRA early in the morning.  Historically, the Treasury has tried to keep T-Bill issuance between 15% and 20% of total Treasury issuance.  However, a look at the current mix shows that Secretary Yellen already has that ratio up to 22.6%.  One of the big questions was how that would play out going forward.

Recall, one of the narratives that has been invoked for the Treasury bond sell-off with corresponding rising yields, has been the supply story.  You know, the US is running massive budget deficits and needs to issue more debt to fund it, so there is a lot more supply coming.  A key assumption in this story was that the mix of debt, which already favored T-Bills, would not change much so the new debt would be forced into the back end of the curve.  Well, that’s not how things worked.  The QRA indicated that the Treasury was going to issue a lot more T-Bills, a total of $1.1 trillion over the next two quarters, raising the proportion of T-Bills to 23.2%, even further above the old ceiling.  Of course, the result is much less issuance in the 5yr and longer space, thus undercutting the excess supply argument.

The results cannot be surprising as even before Powell started speaking, 10-year yields had fallen 11bps although they continued to decline afterwards as well, finishing the day lower by 16bps or so.  All in all, an impressive bond rally.  But let’s consider for a moment a different consequence of yesterday’s announcements, the shape of the yield curve.  Prior to the QRA and the Fed, the yield curve, as measured by the 2yr-10yr spread had fallen from a low of -108bps to just -15bps and it seemed almost certain that it would normalize soon.  However, now that the QRA has shown there will be more issuance out to 2yrs and less beyond, the immediate impact is the curve is going to go back to inverting further, (it is already back to -22bps) at least until such time as the Fed actually does cut rates.  I have a feeling that we are going to hear a lot more about recession again even though Powell explicitly said the Fed was not expecting one.  In fact, Powell and the Fed may be the only people not expecting a recession at this point!

A quick look at the Fed funds futures market shows that for the December FOMC meeting, the market is currently pricing a 20% probability of a 25bp rate hike.  That is slightly lower than before the FOMC meeting yesterday, but within the margin of error.  However, at this point, the market has a 43% probability of a rate cut in May, with that probability growing as you head out further in time.  One of the things Powell reiterated yesterday is that the committee is not even discussing the idea of a rate cut.  Of course, he also said that they don’t believe a recession is coming so it is not surprising the market has a different rate view than the Fed.

In the end, I think this is a seminal shift in policy with the combination of Treasury and Fed actions indicative of a much easier policy stance going forward.  I have built my views based on the Fed maintaining its higher for longer stance and continuing to stress the system which remains massively leveraged.  However, if he is no longer going to follow that path, and I think we learned yesterday that the inflection point is here, then we need to rethink the future.  One consequence of this policy change, though, is that inflation, which I have maintained is going to remain far stickier than many anticipate, is going to become an even bigger problem down the road.  I just don’t know how far down the road that will be.  But for now, I think we are going to continue to see equities rebound into year end, bond yields fall, the dollar fall, and commodity prices rebound.  This is going to be a classic risk-on scenario through the end of the year in my view.

And despite, or perhaps because of, continued weaker data, that is what we are seeing in markets around the world.  Yesterday’s ISM Manufacturing data was quite soft at 46.7, and this morning the PMI data from the rest of the world was generally awful with all European readings between 40 and 45.  Yesterday’s ADP Employment data was soft, at 113K which just added fuel to the policy easing fire and though the JOLTS Job Openings data was still strong, the net perception is slower times are ahead, and with them, lower interest rates.

A look around markets shows that after yesterday’s US rally, with the NASDAQ leading the way higher by 1.6%, Asian shares rallied (Nikkei +1.1%, Hang Seng +0.75%) and we are seeing strength across the board in Europe with all major indices higher by at least 1.25%.  And don’t worry, US futures are pushing higher again, up about 0.5% at this hour (7:15).

It is, of course, no surprise that bond yields around the world are lower with European sovereigns declining by between 7bps and 12bps after both Australia and New Zealand saw yields tumble 16pbs and 25bps respectively.  Even JGB yields are softer by 3bps.  In fact, Dutch central bank president Klaas Knot, one of the most hawkish ECB members, is on the tape this morning with the following quote, “We should be a little patient and not raise rates too much.”  That may be the most dovish thing he has ever said.  The point here is that until such time as inflation really comes roaring back (and I fear that day will come), the direction of travel in interest rates is lower.

Oil prices, which remained under some pressure in the past week, have bounced 1.4% this morning with the movement seeming to be a response to the policy changes while gold (+0.3%) is also climbing, although a bit slower than I might have expected.  But we are seeing strength throughout the commodity complex on the lower rate story with copper (+0.5%) rallying despite the prospects of a recession.

Finally, the dollar is under pressure across the board with the DXY down -0.7% led by the euro (+0.6%), AUD (+0.7%) and NZD (+0.95%).  The yen (+0.4%) is a bit of a laggard today, though remains above the 150 level, but I suspect that we are going to see dollar weakness continue going forward.  Against EMG currencies, we are also looking at a weaker greenback with KRW (+1.0%) leading the way, but strength through APAC and EEMEA and MXN (+0.6%) firmer as the only representative of LATAM that is trading at this hour.  Yesterday Banco Central do Brazil cut their SELIC rate by 50bps to 12.25% as widely expected and BRL rallied 2% on the day.  Again, the theme is now a weaker dollar going forward.

To show how big a deal yesterday was, the BOE meets this morning, and nobody is even discussing it.  Expectations are for no policy change, although perhaps given the sudden dovishness breaking out worldwide, they will consider a cut!  We also see a bunch of US data as follows: Initial Claims (exp 210K), Continuing Claims (1800K), Nonfarm Productivity (4.1%), Unit Labor Costs (0.7%) and Factory Orders (2.4%).   There are no Fed speakers on the schedule today, but they get started again tomorrow.  Remember, tomorrow we also see NFP, so still some fireworks potentially.

For now, though, the new trend is risk on, dollar down.  

Good luck

Adf

A Loose Upper Bound

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One percent is now
A loose upper bound, rather
Than a key level

Yen participants
Saw a signal to sell.  Is
Intervention next?

Below is what appears, to me at least, to be the critical comment from the BOJ after last night’s policy meeting.  As well, that graphic comes straight from the BOJ presentation.

“It is appropriate for the Bank to increase the flexibility in the conduct of yield-curve control, so that long-term interest rates will be formed smoothly in financial markets in response to future developments.”

The essence of this is that YCC as we knew it, where the control part was the key, is now dead.  Instead, Ueda-san is going to allow a great deal more leeway for the market to determine the yield on the 10-year JGB, and the entire yield curve there.  While they have not yet adjusted the policy rate, which remains at -0.10%, I imagine that change is only a matter of time.  Remember, though, the BOJ currently owns somewhere around 56% of the outstanding JGBs in the market.  It is very clear they are not going to sell any.  To me the question, which I did not see answered last night, is whether they will replace the bonds in their portfolio when old ones mature.  There was no mention of QT, but I guess we will have to see.  Based on their history, however, I would expect that the current balance of JGB’s they own will remain pretty constant going forward, at least on a nominal basis.  Given the Japanese government continues to run deficits, that will eventually reduce the percentage of holdings.  Of course, I suspect that this is subject to change if things get politically uncomfortable, but we shall see.

The market response was somewhat counter to what might have been expected.  Arguably, many were looking for a yen rally as higher yields in Japan would create a greater incentive for Japanese institutional investors to bring their money home.  But that is not what happened at all.  This morning, USDJPY is firmly above 150.00 with no hint that there is intervention coming anytime soon.  It seems, at least for now, that the MOF and BOJ are going to allow markets to find a new level by themselves.  If that is the case, I expect that USDJPY is going to revert to form and follow USD interest rates.  In fact, that is really the key, and something about which I have written in the past.  When the Fed turns their policy toward easier money, at that time the dollar will come under significant pressure.  However, until then, the dollar remains the place to be.

In China, the data has shown
The ‘conomy’s not really grown
Will Xi add more cash
To try for a splash
Or will he leave things on their own?

The other news overnight was from China where their PMI data proved weaker than expected for both manufacturing and services with the former falling back below the key 50.0 level at 49.5 and the latter falling to its lowest print since last December during the zero-Covid policy Xi had implemented.  It seems that slowing growth around most of the world plus a limited domestic economic impulse combined with the ongoing collapse of the Chinese property market is just too much to overcome right now.  Expectations are that Xi will agree to yet more stimulus (remember earlier this month they put forth a CNY 1 trillion (~$137 billion) plan, but that has not seemed to have had the desired impact.  At least not yet.  While Japanese equities rallied on the back of the BOJ activity, Chinese equities came under pressure, especially the Hang Seng (-1.6%) although mainland shares fell as well.  As to the renminbi, it continues to grind lower (dollar higher) and remains pegged at the 2% boundary vs. the PBOC’s daily fixing rate.  Nothing has changed my view of further weakness in the renminbi going forward, at least as long as the Fed retains its current policy stance.

If I were to sum up the situation in Asia at this time, I would suggest that the two major economies there are both very busy dealing with substantial domestic economic questions, although those questions are different in nature.  Japan is trying to come to grips with rising inflation absent substantial economic growth while China has a problem defined by weakening growth with inflation not a current issue.  But lack of growth is the common denominator here and as we have seen countless times around the world, I suspect we will see further fiscal stimulus in both nations before long.  

Of course, when it comes to fiscal stimulus, China and Japan are mere pikers compared to the US which has completely rewritten the record books on this matter.  And there is nothing that indicates the US is going to back off, at least while the current administration is in place, and likely the next regardless of the letter after the president’s name.  

On this subject, though, while yesterday I described the QRA as critical, the first part of the Treasury story was revealed yesterday morning when they announced that the funding requirement for Q4 would be $776 billion, some $75 billion less than the consensus estimates before the announcement.  But the key difference was that Secretary Yellen is aiming for an average TGA balance of “only” $750 billion, far less than some estimates of $1 trillion, and less than the current balance of $835 billion.  In fact, the difference between the current balance and the target is what makes up for the difference in the issuance estimates.  Under no circumstances should anyone believe that fiscal prudence is coming soon.

But this lower number has relieved some pressure in the bond market where we have seen yields slide a few more basis points this morning with the 10-year now trading at 4.83%.  This movement has been followed by the European sovereign market, where yields have fallen by between 4bps and 6bps across the board in sympathy.  In fact, the only major market that saw yields rise was the JGB market, where the 10yr yield is now at 0.93%, up 5 more bps from yesterday’s closing levels.  I suspect that we will be trading at 1.00% soon enough, and it will be quite interesting to see just how ‘nimble’ the BOJ will be if yields start to run higher more quickly.

As to equity markets, yesterday’s US rally has been followed by the European bourses, all up between 0.6% and 1.2% despite somewhat soft economic growth data released this morning.  However, Eurozone inflation data was also slightly softer than forecast and it seems traders are looking for the ECB to reverse to rate cuts sooner rather than later.  US futures, meanwhile, are very marginally firmer this morning as all eyes now turn toward tomorrow afternoon’s FOMC outcome.

Oil prices have bounced a bit, up 0.9%, but this seems to be a trading move rather than anything either fundamental or geopolitical.  Regarding the latter, the fact that the beginnings of the Israeli ground invasion of Gaza have not produced nearly the pyrotechnics feared, nor that the conflict has spread throughout the Middle East, at least not yet, has resulted in traders returning their attention to inventories and demand.  Slowing growth in most places around the world is likely the key driver right now.  As to gold, it has maintained its recent gains and is trading right at the $2000/oz level.  Clearly, there is a fear factor there, but remember, if the equity bulls are correct and the Fed is going to tell us they are done, that will be seen as dovish and we should see a reversal in the dollar, a rally in commodities, including gold, and an initial rally in stocks and bonds.  That is not my base case, but you cannot ignore the possibilities.

Finally, the dollar is best described as mixed today as the strength in USDJPY (+1.1%) has been offset by weakness in the greenback vs the euro (+0.4%) and the pound (+0.2%), as well as a number of EMG currencies (MXN +0.4%, PLN +0.5%, ZAR +0.6%).  If one considers the DXY, that is virtually unchanged on the day.

On the data front, this morning brings the Employment Cost Index (exp 1.0%), Case Shiller Home Prices (1.6%), Chicago PMI (45.0) and Consumer Confidence (100.0).  obviously, there are no Fed speakers as their meeting starts this morning and runs through tomorrow afternoon when we will see the statement and Powell will meet the press at 2:30.  

It seems to me like traders will be cautious ahead of the FOMC tomorrow.  I would think they would want more confirmation that the Fed has finished before running back into bonds as well as reversing the recent stock declines.  While the Fed is unlikely to do anything tomorrow, it will be all about the statement and press conference.  Til then, I suspect a quiet time.

Good luck

Adf

A Havoc Nightmare

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While real wages fall
Kishida’s polls fall faster
Will Ueda act?

The first big thing this week is tonight’s BOJ meeting where many in the market are anticipating another tweak to the current YCC framework.  I have seen several analysts calling for a widening of the band to +/- 1.25% from the current +/- 1.00%.  While current yields have yet to reach the cap, they continue to grind higher and are currently at 0.88%, new highs for the move.  Ironically, it is likely the BOJ will need to buy even more JGB’s if they make an adjustment as the wider band would give the green light for speculators to short bonds even more aggressively.  Recall, since they widened from 0.50% to 1.00%, there have been at least five unscheduled bond buying episodes by the BOJ, with the last one, just a week ago, being the largest to date.

One thing to remember about the BOJ is that the concept of central bank independence is not as strong in Japan as it is, perhaps, elsewhere in the Western world.  (Of course, it is not that strong elsewhere either, but Japan is closer to China on this front than the US).  At any rate, the most recent polls in Japan show that PM Kishida’s approval ratings have fallen to new lows for his tenure, with an approval of just 33% according to the most recent Nikkei poll.  And this was after the announcement that he was cutting taxes to help people deal with the consistently rising inflation in Japan.  While it has not grown to levels seen in the US or Europe, it is clearly far higher than they have seen there in more than a generation.

But it doesn’t seem to be enough.  Now, there is no requirement for an election until sometime in 2025, but that doesn’t mean Kishida-san won’t feel the pressure to do more.  And arguably, one of the things they can do to fight inflation is raise rates and see if the yen can recapture some of the 35%+ that it has declined over the past two years.  

So, will they act?  My one observation on this is that unlike the Fed, which never likes to surprise the market, the BOJ has figured out that they only way they can have an impact is if they do surprise the market.  Given that an increasing number of people are starting to look for this outcome, I think the probability of a BOJ policy change tonight is quite low.  I would not be surprised, if I am correct, to see USDJPY head back through 150 and start to grind to new highs above the 152+ peak seen just before the intervention last year.

Meanwhile, for the rest of the week
Both meetings and data might wreak
A havoc nightmare
So, traders, beware
Of comments or data that’s bleak

Beyond tonight’s BOJ meeting, the week is jam-packed with other potential market moving catalysts between central bank meetings (FOMC on Wednesday, BOE on Thursday) and important data including ISM (Wednesday) and NFP on Friday.  However, there is one other thing set to be released Wednesday morning, well before the FOMC announcement and that is the Quarterly Refunding Announcement (QRA).  While, as its name suggests, this is released every quarter, it has generally been relegated to the agate type of market information as a technical feature for bond traders.  But this time, it has gained far more interest given the combination of the bond market’s performance since the last QRA (yields are higher by 80ish basis points) and the fact that the government budget deficit is continuing to grow with many new forecasts for a $2 trillion deficit this year thus a need for even more borrowing. 

Back in August at the last QRA, the Treasury increased issuance more than anticipated which has been seen as one of the drivers of the recent bond market decline.  If they were to increase it significantly again, there is certainly concern that bond yields can move much higher still.  Now, the Treasury could issue more short-term T-bills to take pressure off the bond market but bills already represent about 22% of the total debt outstanding.  That is a couple of points higher than the top of the historic range of 15%-20% and may be seen as a point of contention.  The positive is that given T-bill yields are all above 5.3%, there will be plenty of demand for their issuance.  However, on the flip side, that means that refinancing will need to occur far more frequently and that makes it subject to market dislocations and disruptions.

Another key part of the discussion will be just how large Secretary Yellen wants to keep the Treasury General Account (TGA), which is the government’s ‘checking’ account at the Fed.  As of Thursday, it held $835 billion and there has been talk she wants to increase it to $1 trillion to make sure the government has ample liquidity going forward, especially if there is another issue regarding government financing in Congress.  Historically, the Treasury has issued bills when they are seeking to build up balances in the TGA, which would tend toward seeing even more bills issued rather than substantial growth in the longer-dated maturities.  All in all, it is possible the QRA is going to have the largest potential impact on markets this week so beware.

In truth, the overnight session has been somewhat dull.  While the Israeli-Palestinian situation has seemed to enter a new phase regarding Israel’s incursion into Gaza, markets are non-plussed over the matter with bond yields little changed across the board, the dollar little changed across the board and oil prices sliding (-1.5%) this morning.  Even gold (-0.6%), which has been the best performer in the wake of the middle east crisis, has slipped back below the $2000/oz level, although remains higher by almost 10% in the past month.

In fact, the one area where things are moving is in equity space where we are seeing gains across the board in Europe, somewhere between 0.5% and 1.1%, in the major bourses as inflation data there showed that price rises have begun to slow down and Germany’s economy “only” shrunk by -0.1% in Q3, a much better than expected outcome!  US futures are also higher at this hour (7:15), up by 0.5% or so after a pretty awful week last week.  In fact, the only real outlier was Japan where the Nikkei slid -0.5% as Chinese shares were stronger along with most of the APAC markets.

As mentioned earlier, though, we do have a lot of news coming out this week so let’s go through it here:

TuesdayBOJ Rate Decision-0.1% (unchanged)
 BOJ YCC+ / – 1.00% (unchanged)
 Case Shiller Home Prices1.6%
 Chicago PMI45
 Consumer Confidence100
WednesdayADP Employment150K
 QRA$114 billion (+$11 billion)
 ISM Manufacturing49.0
 JOLTS Job Openings9.2M
 Construction Spending0.4%
 FOMC Decision5.5% (unchanged)
ThursdayBOE Decision5.25% (unchanged)
 Initial Claims210K
 Continuing Claims1795K
 Nonfarm Productivity4.0%
 Unit Labor Costs0.8%
 Factory Orders1.9%
FridayNonfarm Payrolls188K
 Private Payrolls145K
 Manufacturing Payrolls0K
 Unemployment Rate3.8%
 Average Hourly Earnings0.3% (4.0% Y/Y)
 Average Weekly Hours34.4
 ISM Services53.0

Source: tradingeconomics.com

So, as you can see, there is a lot of stuff coming our way starting tonight in Tokyo.  What that tells me is that we are not likely to see very much movement today as traders and investors await the plethora of new information that is due.  However, by the end of the week, we could have a very different narrative.  

Good luck

Adf

Concerns Are Severe

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One look at the dot plot makes clear
Inflation concerns are severe
So, higher for longer
Is growing still stronger
And Jay implied few cuts next year

First, let’s recap the FOMC meeting.  The term hawkish pause had been used prior to the meeting as an expectation, and I guess that was a pretty apt description.  While they left policy on hold, as expected, the change in the dot plots, as seen below, indicate that even the doves on the Fed see fewer rate cuts next year, with just two now priced in from four priced in June.

Source: Fedreserve.gov

A quick reading shows that a majority of members expect one more hike this year, and now the median expectation for the end of 2024 has moved up to 5.125%, so 50bps lower than the median expectation for the end of 2023 and 50bps higher than the June plot.  To me, what is truly fascinating is the dispersion of expectations in 2025 and 2026, where there are clearly many opinions.  And finally, the longer run expectation has risen to 2.5% with many more members thinking it should be even higher than that.  The so-called neutral rate estimations seem to be creeping higher.  If you think about it, that makes some sense.  After all, given the ongoing forecasts for continued labor market tightness due to demographic concerns, and add in the massive budget deficits leading to significantly higher Treasury debt issuance, there is going to be pressure on rates to find a higher level.

The market response was quite negative, albeit not immediately, only after Powell started speaking.  But in the end, equity markets fell across the board in the US, with the NASDAQ taking the news the hardest, down -1.5%, as its similarity to long duration bonds was made evident.  Asian markets all fell overnight as well, with most tumbling more than -1.0% and European bourses are all under similar pressure, down -1.0% or so as well.  The one exception in Europe is Switzerland, where the SNB surprised the market and left rates on hold resulting in a weaker CHF and a very modest gain in their equity market.

However, the bigger market response was arguably in bonds, where yields rose to new highs for the move with the 2yr at 5.15% and the 10yr at 4.43%.  Once again, I point to the significant increase in debt that will be forthcoming from the US Treasury as they need to fund those budget deficits.  I have been making the case that a bear steepener would be the more likely outcome for the US yield curve.  That is where long-term rates rise more quickly than short-term rates due to the US fiscal policy and shrinking demand for US debt by key players, notably the Fed, but also China and Japan.  Nothing has changed that view.

Then early this morning, up north
Both Sweden and Norway brought forth
A quarter point hike
To act as a dike
Preventing price rises henceforth

After the Fed’s hawkish pause, we turn our attention to Europe, where the early movers, Sweden and Norway, both hiked twenty-five basis points, as expected, while both hinted that further hikes are not out of the question.  Inflation remains higher than target in both nations and in both cases, the currency has been relatively weak overall.  Switzerland left rates on hold, pointing to the fact that for the past three months, inflation has been within their target range, and they are beginning to see downward pressure on economic activity which they believe will keep that trend intact.

And lastly, from London we’ve learned
Another rate hike has been spurned
Though voting was tight
They said they’re alright
With waiting to see if things turned

As to the bigger story, the UK, expectations were split on a hike after yesterday’s tamer than expected CPI report while the pound fell ahead of the news.  And the change in expectations was appropriate as in a 5-4 vote, the BOE opted to remain on hold for the first time in two years.  They see that inflation may be easing more rapidly than previously expected, and they are concerned about overtightening.  While I have a hard time understanding how a 5.15% Base rate is tight compared to CPI running at 6.7% and core at 6.2%, I am clearly not a central banker.  At any rate, the pound fell further on the news and is now at its lowest level since March, while the FTSE 100 rallied back and is close to flat on the day from down nearly -1.0% before the announcement.  Gilt yields, however, are moving higher as the bond market there doesn’t seem to believe that the BOE is serious about fighting inflation.

And really, those are today’s key stories.  Late yesterday, Banco Central do Brazil cut the SELIC rate by 0.50%, as expected, and at the same time the BOE announced, the Central Bank of Turkey raised their refinancing rate by 5 full percentage points, to 30.0%, exactly as expected.  And to think, we get concerned over rates at 5%!

As to the rest of the day, there is a bunch of US data as follows: Philly Fed (exp -0.7), Initial claims (225K), Continuing Claims (1695K), Existing Home Sales (4.1M) and Leading Indicators (-0.5%).  As is typical, there are no Fed speakers scheduled the day after the FOMC meeting, but we will start to hear from them again tomorrow.

Putting it all together tells me that the Fed is not nearly ready to back off their current stance and will need to see substantial weakness in economic activity before changing their mind.  Meanwhile, last week’s ECB meeting and this morning’s BOE meeting tell me that the pain of higher interest rates in Europe is becoming palpable and the central banks are leaning more toward inflation as an outcome despite their mandates.  This continues to bode well for the dollar as the US remains the place with the highest available returns in the G10.

Tonight, we hear from the BOJ, where no change is expected.  I would contend, though, that the risk is there is some level of hawkishness that comes from that meeting as being more dovish seems an impossibility.  As such, there is a risk that the yen could see some short-term strength.  Keep that in mind as you look for your hedging levels.  

Good luck

Adf

If Doves Seduced

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The British inflation release
Showed prices did not quite increase
As much as expected
Though still they’re projected
To stay at a level, obese

But truly, all eyes have now turned
To Jay, when past two, we’ll have learned
If hawks rule the roost
Or if doves seduced
The Chairman with more rate hikes spurned

As New York walks into the office this morning, all thoughts are on how the FOMC meeting will play out.  The current expectation is for no rate movement today and still about a 50% chance of one more hike either in November or December.  More remarkably, as I wrote yesterday, is the belief that there will be 100 basis points of cuts next year despite the growing belief of either a soft landing or no landing.  Again, I ask, why would the Fed cut rates if the economy continues to grow with the current monetary policy?  However, at this point, all we can do is wait.

FWIW, which may not be much, I continue to see the outcome as follows; no movement today, 25bps in November and then a reassessment in December based on how the data continues to flow.  Nothing Powell has said indicates that he is comfortable that the Fed has vanquished inflation, and similar to the idea that every politician only cares about one thing, his reelection, I believe Powell is completely focused on just one thing, killing inflation.  He has made it abundantly clear in the past that he expected some economic pain would be necessary in order to achieve that outcome, and he is not going to be deterred at this stage.  It would not surprise me if Fed funds remained at the year-end 2023 rate, whether that is 5.50% of 5.75%, for all of 2024.  In fact, absent a very significant recession, that is what I believe will occur.  One man’s view.

Anyway, turning to the only other data of note today, UK CPI surprisingly fell to 6.7%, down from last month’s 6.8% reading and forecasts for a 7.0% outcome today based on rising energy and food prices.  Even better for Governor Bailey, the core rate fell to 6.2%, well below last month’s level of 6.9% and forecasts of 6.8%.  The pound dipped on the news, but only by -0.2%, as the entire FX complex remains in thrall to the FOMC outcome later this afternoon.  However, this inflation result has pundits asking whether Governor Bailey will be able to skip tomorrow’s rate hike, just like the Fed, and wait until November if they deem it still necessary.  My view here is that will not be the case.  Given the overall weakness in the UK economy, Bailey is clearly running out of room to hike rates, and tomorrow is likely to be his last chance to raise rates before the evidence of sustained weakness becomes clear.  Just like the rest of Europe, I expect the BOE will hike tomorrow and be done.

Once again, I will point out that the basis of my dollar views remains that the US is going to be the most hawkish of all the major economies, maintaining tighter monetary policy far longer than other nations, and that the dollar will naturally see investment flows continue.  After all, the combination of higher yields and potentially better growth prospects will be far too much for international investors to ignore.

For now, though, we wait for 2:00pm and the FOMC statement along with their new Summary of Economic Projections, and then for Chairman Powell’s presser at 2:30.  As such, until then I expect a pretty dull day.

Overnight, Asian equity markets were under pressure with losses in both Japanese and Chinese shares, as well as generally throughout the region.  The only noteworthy news was that the PBOC left rates on hold, which was widely expected, although there were those who thought they might cut again to support the weakening Chinese economy.  European bourses, though, are having a much better day, with all markets higher by at least 0.5% and several southern European nations seeing gains greater than 1%.  Meanwhile, at this hour (7:30), US futures are edging higher by 0.2% or so after modest declines yesterday.

In the bond market, yesterday’s closing level for 10yr Treasuries was the highest, at 4.36%, since October 2007, and although the yield is lower today by about 2bps, this trend remains intact.  The big mover today, though, is UK Gilts which have seen yields drop 8bps after that CPI report.  This has helped drag European sovereign yields lower by about 2bps as traders want to believe that the rate hikes are over everywhere in Europe, and cuts are the next step.  While that’s not my view, it is gaining traction.

In the commodity markets, oil (-1.0%) has finally had a pullback of substance after a rumor yesterday that the Biden administration was going to completely empty the SPR.  There has been no source for that story and no corroboration but given the move that oil has seen over the past 3 months, up more than 35%, a pullback is no surprise.  While there is likely to be a further short-term retreat here, the long-term prospects for oil remain significantly positive in my view.  As to the metals markets, industrials are a bit firmer this morning, perhaps on the idea that the rate hiking cycle in Europe is ending, while gold is unchanged.

Finally, the dollar is a bit softer this morning, but not very much.  The euro remains either side of 1.07 while USDJPY is pushing the 148 level, very close to the key 150 point where many participants believe the BOJ will step back into the market.  As to CNY, its home has been the 7.30 level despite all the effort that the PBOC has expended to strengthen the yuan.  The biggest winners today have been the Antipodeans, with both AUD and NZD firmer by 0.5% after the Minutes of the RBA meeting indicated that they were considering another rate hike at the last meeting although decided to hold off.  The implication is another hike could be in the cards.

On the data front, really the FOMC meeting is today’s only activity of note, although we will see the EIA oil inventories as well.  Until the meeting ends, I expect very little to occur.  Once the announcement is out, and even more importantly, once Powell starts to speak, be prepared for more volatility.

Good luck

Adf

What He’s Sought

Posted on by 
On Monday, the market did naught
As traders were giving much thought
To how Jay explains
The work that remains
For him to achieve what he’s sought

And so, while no change is expected
In rates, look at what is projected
The June dot plot showed
The Fed’s preferred road
Was four cuts will soon be effected

Once again, the overnight activity remains fairly dull as traders and investors around the world await the results of tomorrow’s FOMC meeting.  At this point, it seems quite clear the Fed will remain on hold tomorrow leaving Fed funds in a 5.25%-5.50% range while continuing their QT program.  With this in mind, all the excitement will come from the new Summary of Economic Projections (SEP) which includes the dot plot.  The dot plot is the graphical representation of the FOMC members’ expectations for the path of Fed funds going forward.  Below is the most recent release from the June meeting (chart from Bloomberg).

The chart shows each of the FOMC members’ forecasts for where Fed funds will be at the end of 2023, 2024, 2025 and over the long term.  The green line shows the median forecast which in June indicated a belief there will be one more rate hike in 2023 and then four rate cuts in 2024 with another five cuts in 2025 before eventually seeing Fed funds move back to the perceived ‘neutral’ rate of 2.5%.

However, let us consider how some alternative scenarios might evolve.  For instance, I continue to wonder why the Fed will be cutting rates by 100bps in 2024 if they no longer forecast a recession in the US.  After all, if the economy continues to chug along with rates at 5.5%, what purpose would be served by cutting rates?  And if the economy does enter a recession next year, something which seems realistic, then the Fed will be cutting far more than 100bps.  It’s funny, if you look at the dispersion of expectations for 2024, there is one member who feels certain a recession is coming, with an expected rate of 3.625%, and another one who sees higher for longer as lasting the entire year.  At least those two members are making some sense.  However, the idea that the Fed will cut just because, without a more severe economic shock, seems quite unlikely.  After all, Chairman Powell has invoked the ghost of Paul Volcker numerous times and explained they will not be fooled by a temporary decline in inflation.  Rather, they are in this for the long haul and will win the battle.

There are those who would argue that the Fed will cut rates, regardless of the economic situation, because the US cannot afford to continue to pay interest at the current level on their >$32 trillion in debt.  As such, Powell will feel enormous pressure from the administration to reduce rates to help the government.  Now, that is the exact opposite of central bank independence, but certainly not an impossible outcome.  But absent that type of situation, it strikes me that we remain a very long way from the Fed achieving their target inflation rate of 2.0%.  At this point, the one thing Powell has made abundantly clear is that he will not stop until they achieve that goal.  

Another fly in the rate cutting ointment is the price of oil.  Again, this morning it is higher, +0.8%, and now above $92/bbl and seemingly approaching the magical $100/bbl level.  In the wake of the Russian invasion of Ukraine, the Biden administration released some 300 million barrels from the US’s Strategic Petroleum Reserve (SPR) which helped moderate price increases at the time.  However, the ability to repeat that exercise does not exist as currently, the SPR only holds about 350 million barrels and there are actual physical constraints regarding the integrity of the salt domes in which the SPR is kept.  If too much is released, the domes could cave in.  When considering this alongside the ongoing production cuts from OPEC+ as well as the administration’s effective war on domestic oil production, it is reasonable to conclude that oil prices have higher to climb.  Working our way back to the Fed, the problem is that high energy prices ultimately become embedded in all prices, as even services require energy to be accomplished.  This underlying cost pressure is going to prevent any significant decline in the rate of inflation and, in turn, support the Fed’s higher for longer narrative for even longer.

Wrapping up the discussion, I would contend that absent a sharp recession, the Fed is not going to be pressured into cutting the Fed funds rate anytime soon.  Instead, I expect that we will continue to see longer end rates rise slowly as the combination of massive new issuance of Treasury debt and lingering inflation will require higher yields to find buyers.  Currently, the two largest non-Fed holders of Treasury securities are China and Japan, and both of them have been slowly liquidating their portfolios as they need dollars to sell in the FX markets in order to support their own currencies.  When push comes to shove, I expect that we will see US rates retain their advantage over other G10 currencies and that it will continue for a while to come.  As such, I continue to expect the dollar to outperform, at least until something really breaks.  However, what that something is remains open to debate.

Turning to the overnight session, which was quite uninteresting as mentioned above, we saw mixed to weaker performance in Asian equities, with only the Hang Seng managing to eke out any gains at all, while European bourses are mixed with the major exchanges all within 0.2% of yesterday’s closing levels.  Yesterday’s US performance was as close to unchanged as it could get while being open, and this morning’s futures market is showing tiny gains (<0.1%) at this hour (8:00).

Bond markets are somewhat mixed on the day, with Treasury yields backing up 2bps, while UK gilt yields are lower by 4bps and everything else is in between.  Eurozone final CPI for August was released with the headline ticking down 0.1% to 5.2%, but core unchanged at 5.3%, with both, obviously, still well above the ECB target.  Madame Lagarde must be praying quite hard for inflation to fall further as she made it clear she does not want to raise rates again.  In the end, the Eurozone has myriad problems with sticky high prices and slowing growth, an unenviable position.

Aside from oil’s gains, gold has been performing relatively well lately, which given the dollar’s resilience and higher interest rates seems somewhat odd.  One possible explanation is that there continues to be significant demand in Asia, where, for example, the Shanghai Gold exchange price is currently some $30/oz higher than on the COMEX, and this spread has been growing.  We have heard much about the record amount of gold buying by central banks this year, and this seems of a piece with that outcome.  However, looking at industrial metals, both copper and aluminum are softer this morning as the prospects for Chinese growth diminish and with them so do prospects for demand for those metals.

Finally, the dollar is a bit softer this morning vs. most of its G10 counterparts with NOK (+0.75%) leading the way higher on the back of oil’s continuing rally.  In fact, the entire commodity bloc is at the top of the charts today.  However, in the EMG bloc, we are seeing more of a mixed picture with an equal number of gainers and laggards and none showing exuberance in either direction.

On the data front today, we see Housing Starts (exp 1439K) and Building Permits (1440K) as well as Canadian CPI (3.8% headline, 3.7% core), with both measures rising and keeping pressure on the BOC.  There are still no speakers, so my take is that things will be dull until tomorrow’s FOMC announcement at 2:00pm.

Good luck

Adf

Some Dismay

Posted on by 
While everyone’s certain that Jay
Will leave rates alone come Wednesday
The curve’s longer end
Is starting to trend
Toward rates that might cause some dismay

The problem remains his frustration
That he can do naught ‘bout inflation
As oil keeps rising
It’s demoralizing
For Jay and his rate formulation

The overnight session was quite dull overall with virtually no new data or information on the macroeconomic front and a limited amount of commentary from the central banking and financial poohbahs of the world.  Friday’s desultory US equity market performance was followed by a mixed session in Asia while European bourses are all in the red after the Bundesbank indicated that Germany would have negative growth in Q3.  As well, after last week’s ECB rate hike, we did hear from one of the more hawkish members that further hikes are possible, although listening to Madame Lagarde’s comments, that seems quite a high bar at this time.

So, given the limited amount of new information, it seems that it is time for central bank prognostications.  The first thing to note is that while the Fed is certainly the main act this week, there are no less than a dozen other major interest rate decisions due this week including the BOE, BOJ, PBOC, Swedish Riksbank, Norgesbank, SNB and Banco Central do Brazil.  

While much has been written about the FOMC on Wednesday, with the current market pricing just less than a 1% probability of a hike, the European banks that are meeting are all expected to follow the ECB and hike by 25bps.  Meanwhile, the PBOC remains caught between a rock (slowing economic growth) and a hard place (a weakening currency) and seems highly likely to follow the Fed’s lead and leave rates on hold.  

The BOJ is also very likely to leave their rate structure on hold, but questions keep arising regarding any other potential tweaks to the YCC framework.  However, given the relatively strong denials of anything like that from Ueda-san at the end of last week, I am inclined to believe they are comfortable where they are.  

Finally, a look down south shows that Brazil is forecast to cut the SELIC rate (their Fed funds equivalent) by 50bps to 12.75% with a handful of analysts calling for a 75bp cut.  Of course, inflation in Brazil has fallen from effectively 12% last summer to 4.65% now, so real rates are still remarkably high there which is the key reason the real has been such a great performer over the past twelve months, having risen ~8%.

The only market that is really showing much movement is oil, which is higher yet again this morning, by another 0.5% and now above $91/bbl.  It is becoming very clear that the OPEC+ production cuts are having the impact that MBS desired, with tightening supply meeting ongoing demand growth, despite slowing economic activity.  The one thing that should remain abundantly clear to all is that no amount of effort by Western governments to reduce demand for fossil fuels is going to have the desired impact as developing nations will not be denied their opportunities to improve their own economic situation and that generally takes access to energy.  To date, fossil fuels continue to prove to be the most cost-effective and efficient sources, so that demand will just not abate.  Oil prices are going to continue to head higher, mark my words.

And truthfully, on this rainy Monday morning in NY, that is pretty much all the excitement that we have ongoing.  The data this week is focused on Housing and expectations are as follows:

TuesdayHousing Starts1437K
 Building Permits1440K
WednesdayFOMC Rate Decision5.50% (current 5.50%)
ThursdayInitial Claims225K
 Continuing Claims1695K
 Philly Fed-1.0
 Existing Home Sales4.10M
 Leading Indicators-0.5%
FridayFlash PMI Manufacturing48.2
 Flash PMI Services50.6

Source: Bloomberg

A side note regarding the data is that the Leading Indicators Index is forecast to decline again, which will be the 17th consecutive decline, a very strong indication that future economic activity seems likely to suffer.  Of course, this is just one of the numerous signals of an impending recession (inverted yield curve, ISM/PMI sub 50.0, etc.) that have yet to play out as they have done historically.  Perhaps the UAW strikes will be enough to tip things over, especially if they widen in scope, but that seems premature. 

In addition, we are beginning to hear more about a potential government shutdown as the House has not yet completed its funding bills but my take here is that while the rhetoric may heat up, the reality is that a continuing resolution will be passed and that this is just another tempest in a teapot in Washington, SOP really.

When looking a little further ahead, I continue to see a far better chance that the Fed remains the most hawkish of the major central banks, and that higher for longer really means just that.  Economic activity elsewhere, notably in Europe and China, is suffering far more acutely than in the US, at least statistically, and that implies that this week’s rate hikes across the UK and the continent are very likely the end of the cycle.  I am not convinced that the Fed is done.  That combination leads me to continue to look for relative dollar strength over time.  For asset/receivables hedgers, keep that in mind.

Good luck

Adf

Resolutely

Posted on by 
Said Jay to the world through the Press
We’ve certainly had some success
But patience is key
As resolutely
We stop any signs of regress

Does this mean that next time we meet
Our actions will be a repeat?
The answer is no
We’re not certain, though
We could if inflation shows heat

And what about Madame Lagarde
Have she and her minions been scarred
By Europe’s recession
Or will their suppression
Of growth lead to outcomes ill-starred

By this time, you are all almost certainly aware that the Fed raised the Fed funds rate by 25bps as widely expected.  You may not be aware that the FOMC statement was virtually identical, with only a change in the description of economic growth from ‘modest’ to ‘moderate’, apparently a slight upgrade.  This was made clear when Chair Powell, at the press conference, explained the Fed staff was no longer forecasting a recession in the US.  Perhaps the following Powell quote best exemplified the outcome of the meeting, “We can afford to be a little patient, as well as resolute, as we let this unfold,” he said. “We think we’re going to need to hold, certainly, policy at restrictive levels for some time, and we’d be prepared to raise further if we think that’s appropriate.”  

So, what have we learned?  I think we can sum it up by saying nothing has changed the Fed’s mindset right now.  They continue to focus on the fact that inflation remains above their target and will continue to implement policies that they believe will address that situation. 

The thing that makes this so interesting is everybody seems to have a different interpretation of what that implies.  The two broad camps are 1) this was the last hike as inflation continues to fall and they are already hugely restrictive compared to their historical activities; and 2) given the upgrade in economic forecast, and the fact that inflation seems set to remain higher than target for a long time yet, there are more hikes to come.Given the math that goes into the CPI data, it is quite easy to forecast Y/Y CPI if you assume a particular M/M figure for the next period of time.  BofA put out a very good chart showing the potential evolution of headline CPI going forward.

The implication here is that unless the M/M data falls to zero or negative, CPI is going to start climbing again.  The Fed clearly knows this as does the market.  The only disconnect is the question of how the Fed will respond in the various cases.  Remember, too, that oil and gasoline prices have risen 13.7% and 11.2% respectively in the past month.  The idea that the energy component of CPI will do anything but rise sharply this month seems absurd.  As such, I expect that the Fed will continue to lean toward another hike going forward.

The problem they have had is that the pass-through from Fed rate hikes to the economy has been greatly diminished by their previous policy of excessive ZIRP.  It is estimated that roughly 80% of US home mortgages have fixed rates below 4%, with half at 3% or less.  At the same time, the average duration of corporate debt has lengthened to 6.4 years as the refinancing activity that occurred during the ZIRP period saw extension of tenors widespread.  As such, other than the Federal government, who managed to shorten the duration of their outstanding debt during the period of ZIRP, most borrowers are in pretty good shape and not impacted by the Fed’s policies.  In fact, they are earning much more on their cash balances.  The point is, there is a case to be made that the Fed can maintain ‘higher for longer’ for quite a while without having a significantly deleterious impact on the economy.  Perhaps the soft landing is possible after all.

Now, if they continue to hike rates, and there are a number of analysts who believe we are heading to 6% or beyond, things may change.  We are already seeing a significant diminution of demand for bank loans, which while that may not bother large corporates, implies that the SME sector is going to break first.  Does the Fed care about them?  They will only care when the Unemployment Rate rises substantially.  This comes back to why I believe that NFP is still the most important data point, regardless of the inflation discussion.  Summing it up, the Fed will see two more CPI, PCE and NFP reports before they next meet on September 20th.  It is impossible, at this time, to estimate their actions with this much more data still to be digested.  However, if my inflation view is correct, that it will remain stickily higher, I see a very good chance of at least one more Fed funds rate hike.

A quick look across the pond shows that the ECB will be making their latest rate decision this morning with the market expecting a 25bp hike.  Unlike in the US, the OIS market is pricing in one further hike after today’s and then that will be the end of the cycle.  But…can Madame Lagarde continue to tighten policy if Europe is actually in a recession?  We already know that Germany is in a recession, and forecasts for Q2 GDP in Europe, to be released next week, are at 0.3%.  The Citi Economic Surprise Index remains mired at -136.7, a level only seen during Covid and the GFC, hardly the comparisons desired.  I believe it will be much tougher for an additional rate hike by the ECB unless the data story turns around quickly, and I just don’t see that happening.  Overall, it is this dichotomy in economic activity that underlies my bullish thesis on the dollar.

At any rate, the market response to the FOMC has been one of sheer joy.  Well, that and the fact that there are still some pretty good earnings results getting released, at least relative to recent expectations, if not on a sequential basis.  But it is the former that matters as that is what gets priced into the market.  So, equity markets, after yesterday’s breather in the US where they didn’t rise sharply, are mostly higher around the world.  Both the Hang Seng and Nikkei rallied nicely, and European bourses are quite robust this morning, with many exchanges higher by > 1%.  US futures, too, are in the green, with the NASDAQ showing great signs of strength.

Meanwhile, bond yields have edge a touch lower virtually everywhere with most of Europe seeing declines between 1bp and 2bps, although Treasury yields are less than 1bp lower this morning.  There appears to be little concern that Madame Lagarde is going to spoil the party and sound uber hawkish.  Even JGB’s are a touch softer, -0.4bps, as the market prepares for tonight’s BOJ announcement.  However, there is absolutely nothing expected out of that meeting.

In the commodity space, oil (+1.1%) is higher again this morning as are gold (+0.25%) and the base metals (CU +0.1%, Al +0.6%).  The soft(no) landing scenario seems to be gaining some traction here.  Either that, or the dollar’s weakness today, which is widespread, is simply being reflected as such.

Speaking of the dollar, it is definitely on its back foot as the market is essentially saying the Fed is done.  It is softer vs. the entire G10 bloc, with NOK (+1.05%) leading the way on the back of oil, but SEK (+0.9%) and NZD (+0.7%) also rising nicely alongside the commodity space.  Even the euro, which has no commodity benefit whatsoever, is firmer this morning by 0.5% as the market awaits Madame Lagarde.

In the emerging markets, the picture is similar with almost every currency firmer vs. the buck led by HUF (+1.1%) and ZAR (+0.8%).  The rand is clearly a commodity beneficiary, while the forint has gained after a story about the ECB being willing to consider Hungarian legislation that will avoid the need to recapitalize the central bank despite its recent losses.  Meanwhile, the laggard is KRW (-0.25%) which seems to have responded to the widening interest rate differential between the US and South Korea.

On the data front, we see Q2 GDP (exp 1.8%, down from 2.0% initially reported), Durable Goods (1.3%, 0.1% ex Transport), Initial Claims (235K) and Continuing Claims (1750K) along with several other tertiary figures.  There are no Fed speakers on the docket for the next week and I suppose that given the relative calm following yesterday’s meeting, there is not a great deal of near-term concern they need to change any views.  I suspect that if tomorrow’s PCE data surprises, we could start to hear more soon.

Today, the mood is risk on and sell dollars.  Barring a remarkable surprise from Lagarde, I would not fade the move.

Good luck

Adf

Baked in the Cake

Posted on by 
A quarter is baked in the cake
Ere next time, when Jay takes a break
At least that’s the view
Of so many who
Get paid for, such statements, to make

The question, of course, is why Jay
Would wait, lest inflation’s at bay
The narrative, though,
Is all-in that low
Inflation is now here to stay

Well, it’s Fed Day so all focus will be there until this afternoon at 2:00 when the Statement is released and then, probably more importantly, at 2:30 when Chairman Powell begins his press conference.  Under the guise of a picture is worth a thousand words, I believe the next two charts, both unadulterated from Bloomberg are very effective at describing the current market expectations.  The first is a tabular and graphic depiction of the Fed funds futures market over the next year, which shows that today’s hike is fully priced in, and then there is a just under 50% probability of a hike either September or November.  After that, though, the market is convinced that Fed funds are going to fall, with more than 100 basis points of decline priced in through 2024.

Now, compare that to the second chart, the Dot Plot from the June FOMC meeting:

In truth, the two curves look pretty similar with perhaps the biggest difference the Fed’s current belief that they will absolutely hike twice before the end of 2023 rather than simply a 50% probability of such.  So, can we just assume this is the way things are going to be?  After all, if markets and the Fed agree on the same outcome, it seems likely to be realized, no?

Alas, this is where the narrative is based on crystal balls, not on data.  Whether it is the punditry or the Fed (or the FX Poet), nobody knows how things are actually going to play out.  One of the things that seems to be a throwaway line by every Fed speaker but is actually the most important part of the commentary is that their views are based on, ‘if the economy evolves as we expect it to.’  The problem is that the history of Fed prognostications is awful. 

Obviously, the most recent glaring error was the ‘inflation is transitory’ narrative that they peddled for a year while inflation was rising sharply for many very clear reasons.  Why we should think that their modelling prowess has improved since then is beyond me.  I have often opined that the problem for the Fed is that every one of their models is broken since they don’t accurately reflect the economy, not even a little bit.  Add to that the underlying premise which is that inflation is naturally at 2% and will head back there on its own, something with exactly zero empirical or theoretical support, and you have a recipe for policy errors.  

The latest policy error was the transitory delay, but perhaps the bigger problem for the Fed is the potential for a relatively unprecedented set of economic variables with higher than target inflation combined with slow economic activity yet low unemployment (due to the shrinkage of the labor force.). I don’t think their playbook has a play to address that problem and I fear that the politics of the outcome will have a disproportionate impact on any policies they implement.  If there is one thing of which we can be sure, it is that political solutions to economic problems are the worst kind with the longest-term negative impacts.  

It is for this reason that Powell’s press conference is so widely anticipated as that is where we will learn any new information.  But until then, I expect that markets will remain relatively benign.

A quick tour of the overnight session shows that there was no follow through to Monday night’s Chinese equity performance with the main exchanges in China and Japan all modestly lower.  Europe, however, is having a much tougher time this morning with the CAC (-2.0%) leading the way lower as concerns seem to be growing over the ongoing central bank tightening policies continuing into a recession.  There was vanishingly little data and no commentary of note, but we have seen some weaker than expected earnings numbers out of the continent, a sign that not all is well.  As to US futures, they are essentially unchanged at this hour (8:00) as investors await this afternoon’s Fed meeting.  I would be remiss, though, not to point out that there were several worse than expected earnings numbers, notably from Microsoft, which is a chink in the armor of the idea of infinite growth for AI.

Meanwhile, bond markets are under pressure in Europe with yields higher across the board there, on the order of 2.5bps to 3.5bps.  This appears to be a move based on expectations of continuing higher interest rates from the ECB.  Treasury yields, though, are unchanged on the day, and at 3.88%, currently sit right in the middle of the trading range we have seen for 2023.  As to JGB yields, they slipped 2bps last night with limited concern that Ueda-san is going to rock the boat tomorrow night.

Oil prices (-1.0%) are a bit softer, but this looks like a trading correction after a strong run higher rather than a fundamentally based story.  Base metals are also softer this morning as the Chinese inspired euphoria seems to have dissipated quickly while gold (+0.4%) is creeping higher despite rising yields and a modestly firmer dollar.  It appears to me there is an underlying bid to the yellow metal that will not go away regardless of the macro situation.

Finally, the dollar is slightly firmer this morning as risk aversion seems to be supporting the greenback.  JPY (+0.35%) is the G10 outlier on the plus side with the commodity bloc under the most pressure (AUD -0.7%, NOK -0.7%, SEK -0.5%).  In the emerging markets, THB (+0.7%) has been the best performer after a surprisingly positive Trade Balance with a large negative one anticipated.  However, the rest of the EMG space is mixed with some very weak currencies (HUF -1.0%, ZAR -0.9%) and some other modestly strong ones (BRL +0.4%, MYR +0.3%).  The forint story continues to revolve around central bank activity, with concerns they will ease policy with inflation still high, while the rand is simply suffering from its commodity basis.  Meanwhile, the real jumped after Fitch upgraded the country’s debt rating BB (stable) from BB-.

Ahead of the FOMC decision, we see New Home Sales (exp 725K) but that will be a nonevent given the afternoon’s agenda.  It is a fool’s errand to try to anticipate exactly how Powell will respond to the questions he receives, or even exactly how they will phrase their current views.  As such, today is one to watch and wait, then evaluate afterwards.

Good luck

Adf

Firmly On Hold

Posted on by 
For now the Fed’s firmly on hold
While Powell made statements quite bold
It’s time to assess
How great is the mess
Created by stories we’ve told

This morning then, Christine is live
With certainty that twenty-five
Is how much she’ll hike
As she tries to spike
Inflation while growth she’ll still drive

To virtually nobody’s surprise, the Fed left policy rates on hold yesterday after what has been characterized by many as a hawkish pause.  This seems a fair assessment given the effort by Chairman Powell to stress that inflation remains too high and has not been falling as rapidly as they would like to see.  For instance, comments like the following during the press conference were quite clear:

 

“If you look at core PCE inflation over the last six months, you’re not seeing a lot of progress. It’s running at a level over 4.5%, far above our target and not really moving down. We want to see it moving down decisively, that’s all.”

“We’re two-and-a-quarter years into this, and forecasters, including Fed forecasters, have consistently thought inflation was about to turn down and typically forecasted that it would, and been wrong.”

“What we’d like to see is credible evidence that inflation is topping out and then getting it to come down.”

 

These were just some of the comments but give a flavor for what the mindset appears to be in the Eccles Building.  Looking at the dot plot, the median expectation is for two more rate hikes in 2023 and there were zero expectations of a rate cut.  The point is that higher for longer, which is what they have been preaching for upwards of a year, remains the mantra and given how robust the employment situation remains, they do not seem likely to change that view in the near term.  A quick look at the Fed funds futures market shows a market probability of 71% for a rate hike in July where things peak, and then pricing for a cut in January.  However, as I have maintained, I see inflation remaining quite sticky and the probability of a rate cut as far lower than that.

 

The market response was perfectly sensible in the bond market, where yields continue to climb, and the yield curve inversion increased to -91bps.  2-Year yields are now back to 4.73% as traders and investors price in a much higher probability that even if rates don’t rise much further, they are unlikely to fall back.  In fact, 10-Year yields around the world have all risen further as the global tightening cycle seems set to continue.  Recall, we saw Canada, Australia and now the Fed come out hawkishly and this morning the ECB is set to follow suit with a 25bp rate hike.  At this stage, there are no G10 central banks that believe they have solved the inflation problem…and they are right.

 

A quick look at European sovereign yields ahead of the ECB announcement shows they have risen between 5bps and 10bps this morning as there is clearly an expectation that after the extremely hawkish commentary from Powell yesterday, Madame Lagarde will be forced to follow suit.  In truth, that seems a reasonable expectation and when looking at the OIS market in Europe, expectations appear to be for another one or two hikes after today’s move.  Given that inflation remains sticky there too, that doesn’t seem far-fetched.

 

On last thing regarding central bank hikes is the Bank of England next week, where a 25bp hike is fully priced, but more impressively, an additional 4 hikes are priced in by the end of the year.  Inflation in the UK has clearly been even more problematic than in the Eurozone or the US, while the Old Lady has been lagging lately so this does make sense as well.

 

There are, though several places where tighter policy is not on the cards, namely China and Japan.  Starting with Japan first, YCC remains the current policy framework and there is no indication they are going to change things anytime soon.  10-year yields there remain well below the YCC cap and there is much more discussion regarding the potential for a snap election in Japan than about monetary policy.  The yen (-0.8%) is weakening further today as the more hawkish Fed combined with the continued dovishness of the BOJ weigh on the currency.  We’ve seen this movie before when the dollar ran up above 150 in October, and while that is still a long way from today’s price, the trend since March has been very clear.  Absent a major policy change from either the Fed or the BOJ, look for a weaker yen over time.

 

As to China, they did cut their Medium-Term Lending Facility rate by 10bps last night as widely expected although the currency did not really move as it was fully priced already.  However, the Chinese government is clearly flailing about for ways to support the economy without increasing the leverage that already exists.  The problem is that the PBOC toolkit, as well as the CCP toolkit, relies on centralized direction not market activity, and it appears that the limits of those policies are starting to be reached.  There is little reason to believe the renminbi is going to rebound in the short-term as a weaker currency is the only outlet valve they have.  Given measured inflation in China has been so low, I expect we can see a continued grind lower (dollar higher) in the second half of the year.  Think 7.50 by Christmas.

 

With all that news, US equity markets had a mixed picture yesterday with the NASDAQ continuing its run higher with a small (0.4%) gain, but the rest of the market under more pressure.  Chinese equities responded quite positively to the rate cut there with substantial gains, but the Nikkei was simply flat on the day.  And now, European bourses are in the red by about -0.7% with US futures also pointing lower.

 

Oil prices (+0.75%) are edging higher but that is after a reversal yesterday brought them back below $70/bbl.  There remains a great deal of controversy over just how badly demand is going to be hit given the lackluster Chinese economy and the huge split on views regarding the US and Europe with a recession call still quite popular although there are those who are now calling for a successful soft landing by the Fed.  Precious metals are a little less precious this morning as are base metals which are indicative of dollar strength I believe.  However, net, I would say the commodity space is more in the recession camp than not.

 

Finally, the dollar is stronger vs virtually all its EMG counterparts with HUF (-1.25%) the laggard as market participants take profits in anticipation of a rate cut from Hungary vs. the Fed’s tough talk.  But the bulk of the bloc is weaker across all three regions.  In the G10, while the yen is worst off, we are seeing weakness almost everywhere except NOK (+0.3%) which is clearly benefitting from oil’s modest rally.  Given the Fed’s unambiguous hawkishness, I suspect the dollar will remain better bid than not for a while yet.

 

On the data front, there is a lot coming today as follows:  Retail Sales (exp -0.2%, +0.1% ex autos); Initial Claims (245K); Continuing Claims (1768K); Empire Manufacturing (-15.1); Philly Fed (-14.0); IP (0.1%); and Capacity Utilization (79.7%).  At this point, the Retail Sales data is likely the most important as the discussion regarding a recession will hinge on whether or not economic activity is still improving.  Remember, though, this data is nominal, not inflation adjusted.  On a real basis, Retail Sales have been falling for 6 months straight, not a good sign.  As to the Fed speaking slate, nobody is on the calendar today, but we will hear from three (Bullard, Waller and Barkin) tomorrow, with all likely to be focused on reiterating the hawkish message.

 

A hawkish Fed bodes well for the dollar going forward, so unless (until?) something in the US economy breaks, my money is on higher rates and a stronger dollar.

 

Good luck

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