Tag Archives: #FX

Rise and Shine

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Though CPI’s print was benign
It’s clear that it didn’t enshrine
The impact of war
That caused crude to soar
Thus, yields round the world rise and shine

But other than yields heading higher
And prospects for peace looking dire
Most markets lack motion
Which leads to the notion
That not very much may transpire

It seems incongruous but despite the war, and a remarkable cacophony from the press, markets are not really doing very much at all.  Certainly, at the margin, there is some movement, and, of course, this does not include oil prices which have been all over the map, but generally, if you look at the charts below, it is hard to get too excited.

Starting with the dollar, as per the DXY, it has traded in a 4% range for basically the past year, touching both top and bottom three times each.  The current rebound looks almost identical to the October rally.  But 4% is just not that much of a move, certainly not one that implies a regime change.  Overnight, the largest move was PLN (-0.4%) with virtually every other counterpart, whether G10 or EMG, +/-0.25% or less.

Source: trading economics.com

Turning to stocks, it is difficult to look at the below chart of the S&P 500 and come away with the conclusion that it is either rallying or declining in any meaningful measure.  For the past 6 months, the range has been about 450 S&P points, which, given the level, works out to less than 7%.  It is no surprise that equity volatility is a bit higher than currency volatility, but this chart does not instill fear of either collapse or breakout to my eyes.

Source: tradingeconomics.com

Yes, this morning there is rising concern and equity markets around the world had a weak session overall, but nothing indicating a collapse.  Consider in Asia we saw the following movement:

  • Tokyo -1.0%
  • Hong Kong -0.7%
  • China -0.4%
  • Korea -0.5%
  • Taiwan -1.6%
  • India -1.0%
  • Australia -1.3%

A weak performance?  Absolutely.  Unprecedented declines?  Not even close.  The same is true in Europe, but even less so, with Spain (-0.7%) the worst offender by far while France (-0.3%), the UK (-0.3%) and Germany (0.0%) all tread water.  Again, where is the fear?  US futures, at this hour (6:50) are lower by just -0.4%, again, soft but not catastrophic.

Turning to bonds, while Treasury yields climbed 7bps yesterday, and have been rising since the beginning of the month, they are just now at the top (and slightly through) the range of the past 6 months.  Now, the recent rise is understandable as we all know that yesterday’s benign CPI reading didn’t include any of the oil price movement since the Iran war began.  My understanding is that the rule of thumb for headline CPI is that every $10/bbl rise translates to 0.2% higher CPI.  So, with this morning’s WTI price at $91.50/bbl, compared with $65/bbl prior to the first attacks, that is about 0.5% higher CPI ceteris paribus.  Now, ceteris is never paribus, so we don’t know how things will actually play out, but it seems a fair bet headline inflation will be higher next month.  (This is the point where I will highlight the best way to take advantage of the rising CPI is through USDi, the fully-backed CPI tracking currency.  We already know that CPI next month is going to be higher because of the catch up from the October government shut down.  Add to that the oil price moves and we are looking at annualized returns in the coin of 4.5+% over the next quarter, well above T-bills!)

Back to the bond market, a look at the chart shows the chopping action described above, just like the dollar’s price action.

Source: tradingeconomics.com

This is the Treasury story.  Elsewhere around the world, things have not been quite as benign.  For instance, German bund yields have, this morning, traded to their highest level since October 2023 as per the below chart, although, in fairness, the rise has been gradual.

Source: tradingeconomics.com

UK gilts, on the other hand, have been somewhat more volatile, although I suspect that has a great deal to do with UK domestic economic policy as the nation continues its effort at suicide by insisting that Net Zero CO2 output is the way of the future, thus crushing economic output while suffering through remarkably higher energy prices, and the corresponding inflation that comes with that.  But even here, while the price action has been choppier, the result so far has been similar, a sharp rise in the post Covid recovery reaching a plateau.  

Source: tradingeconomics.com

The fear here, and across all bond markets, is that the Iran war lasts much longer, that oil prices continue to rise, perhaps back to the post Ukraine invasion levels of $120 or higher, and that inflation reignites.  History has shown that every time oil prices rise swiftly and remain there for any length of time, it leads to a recession or at least coincides with one as per the below chart from the FRED database.

Remember, recessions are called after the fact, so my take is the NBER goes back to include the spike.  But it is not a hopeful chart.

On the subject of oil, this morning it is higher by 4.2% as news that Iran has begun to mine the Strait of Hormuz has the narrative updating to explain that the Strait will be closed for an extended length of time and so some 20% of global oil supplies will be off the market.  Now, this is not strictly true as Iran is still transiting the Strait and sending those cargos to China, and I read that India is trying to negotiate for oil heading there to get through as well.  Nonetheless, there is a significant backup there and production is starting to get shut in, which is never a good sign.  While we remain far below the Sunday night panic peak, there is nothing to say we cannot climb back there if things deteriorate in Iran.

Source: tradingeconomics.com

Which takes us to the metals markets.  After a remarkable run over the past two years, gold (0.0%) appears to be settling into a new trading range, as does silver (+1.75%).  

Source: tradingeconomics.com

The funny thing about this is that gold has historically been seen as an inflation hedge, so with inflation almost guaranteed to be higher for the next several months, at least, one might expect gold to rally more aggressively.  One consideration is that with inflation rising, expectations are for rising interest rates which, correspondingly, are negative for gold, so there is no buying. (H/T Alyosha for that narrative.). But perhaps the explanation is that gold has historically been a hedge for monetary inflation, meaning the printing of more currency.  If inflation is caused by a spike in energy prices, gold typically sits on the sidelines. 

Which takes us to the Fed.  If Powell and friends look at inflation and decide that they need to raise rates to address it, that would be a double negative for gold in my view as not only would interest rates be higher, but it would almost certainly trigger a recession.  Initially, that would not be a gold positive, although their response to the ensuing recession, which would be significant policy ease, would definitely send the barbarous relic soaring again.  

So, that’s how I see things this morning.  some market chop, but nothing really changing.  I suppose that we will need to see a conclusion of some sort in Iran to change opinions because, if things drag on, just like they did in Ukraine, investors forget about it after a while.  For instance, how many of you remember Venezuela, which was just 2 months ago.  Attention spans these days are very short.

On the data front, Initial (exp 215K) and Continuing (1850K) Claims lead this morning alongside the Trade Balance (-$66.6B) and Housing Starts (1.35M) and Building Permits (1.41M).  There is also a 30-year auction today, although nobody has been discussing auctions at all lately.  

You will not be surprised that I am not excited by the current market situation, and in fact, my take is the bigger risk for a large move is a sudden end to the Iran conflict, rather than anything else.  In the meantime, I am hunkering down.

Good luck

Adf

Impacts of War

Posted on by 
The financial impacts of war
Are many, and so here are four
Inflation will rise
And what this implies
Investors, most bonds, will abhor

The dollar is like to remain
Demanded and that will cause pain
For stocks everywhere
But one thing will fare
Just fine, look for gold, more, to gain

Obviously, the war in Iran remains the top story and is likely to remain so for a few more weeks at least.  Arguably, the only way this will change is either a regime change takes place and talks for peace begin, or Iran is able to retaliate in a heretofore unknown fashion sufficient to force the US and Israel to withdraw.  President Trump has indicated he believes this campaign will last 4-5 weeks with that regime change the result.  But remember, the Russia/Ukraine war slipped from the headlines after 6-8 weeks, and it is still ongoing.  In fact, I challenge you to find a story about that war anywhere these days.

My point is, despite the ongoing hostilities, the rest of the world continues on its way, albeit with some new bumps in the road.  Clearly, the biggest bump remains the price of oil and, for much of Europe and Asia, its continued availability.  While the price of oil (+0.1% today) has risen about 18% in the past month, a look at the long-term chart below offers a bit more perspective as to just how limited this movement has been so far.

Source: tradingeconomics.com

I have highlighted the week of the Russian invasion from February 2022, which saw oil rise more than 20% at the time and remain elevated for about 5 months before it retraced to prewar levels.  The reaction this time has not been nearly as dramatic even though the effective closure of the Strait of Hormuz has removed about 20% of global oil supply from the market right now, as well as a similar proportion of LNG.  This is why we have seen the massive spike in European and Asian LNG prices as that was the destination of those cargoes.  Ironically, one of the most negatively impacted nations is China, which was Iran’s biggest oil customer, but now has seen a dramatic decline in the availability of oil. Of course, they have built a significant stockpile, their own SPR, which holds between 1.2 -1.5 billion barrels, enough to supply the nation for upwards of 4 months.  While not an immediate concern, it will start to hurt after a while if this continues.

It appears to me that unless Iran starts targeting and destroying oil production facilities throughout the Middle East, which is certainly possible, the upside for prices from here is limited under current circumstances.  My guess, and it is just that, is another 10%.  Of course, the risk for Iran there is that it draws the Saudis, Emiratis and the rest of the Gulf into the war against Iran, probably not a desired outcome either.  

As an aside, I wonder if prices rise far enough in a worst-case scenario, if the UK removes its drilling restrictions, although thus far, PM Starmer has not indicated anything of the sort.  It depends on just how painful things become I suppose.

Moving on to the equity markets, while US markets have declined somewhat since the war began, the S&P 500 remains just 2.5% below its all-time high set February 28, and as you can see from the chart below, does not appear to be altering the recent trajectory in any meaningful fashion.

Source: tradingeconomics.com

However, the same cannot be said for several other markets, notably those in Asia.  The Kospi (-12.1%) is the worst offender as seen below.  But weakness in the region was widespread with the Nikkei (-3.6%), Hang Seng (-2.0%), Taiex (-4.3%) and Thailand’s SET 50 (-5.4%) leading the way lower with most other bourses falling on the order of -1.0% to -2.0%.  This makes sense as virtually all these nations rely on energy from the Middle East, and with both higher prices and reduced supply, trouble is afoot.

Source: finance.yahoo.com

Of course, as you can also see in the KOSPI chart above, with similar price action elsewhere in the region, these stock markets have been on a tear given their tech focus (Korea’s two largest companies are Samsung and SK Hynix, both semiconductor manufacturers) so there was some room for a reversal.  In fact, remarkably, despite the KOSPI having fallen almost 20% this week, it remains above its trend line.  My take is this is a major correction and something we will see until things in the Middle East settle down.

Working in favor of my correction explanation is the fact that European bourses, which all fell sharply yesterday, are all higher this morning as per the below Bloomberg table.

 As to US futures, at this hour (7:30) they are little changed. 

Turning to the bond market, after some initial fears over the inflation implications of the war, as well as the selling that accompanies margin calls, yields have settled down a bit.  This morning Treasury yields (+2bps) are a touch higher but, at 4.08%, hardly running away.  As to European sovereign yields, they are essentially unchanged this morning, and even JGB yields (-2bps) slipped a bit last night.  As I discussed above, markets have digested much of the news and seem to have found a new equilibrium

I didn’t mention metals markets above, but this morning, in sync with other markets that are rebounding, we see the entire space higher; Au +1.7%, Ag +4.3%, Cu +1.1%, Pt +3.8%.  This story of insufficient supply to meet ongoing industrial demand has not changed, nor has the demand by both central banks and individuals, especially in Asia, to hold gold as a store of value.

Finally, the dollar is backing off slightly this morning, which given the price action elsewhere, makes perfect sense.  In the G10 space, the movement has been on the order of 0.1% to 0.2% for the majors (EUR +0.2%, GBP +0.1%, AUD +0.1%, CHF +0.2%) with only JPY (+0.35%) and SEK (+0.8%) showing real gains.  However, it is important to remember that SEK was one of the worst performers recently, so had more ground to regain.  As to the EMG bloc, movement there has been more substantial, but again, this is after much larger declines.  For instance, BRL (+0.6%) and KRW (+0.9%) have both seen sharp declines in the past week before reversing overnight as per the below chart.

Source: tradingeconomics.com

However, if we look at the DXY as our proxy, it remains in the middle of its trading range of the past 9+ months.

Source: tradingeconomics.com

In sum, we are three trading days into an entirely new geopolitical situation, and markets have digested the news and are seemingly trying to return to some sense of normalcy.  Now, there is still significant headline risk as nobody knows how things will evolve here.  What I will say is that if the Iranian regime falls or capitulates, I would look for risk to be quickly scooped up while oil prices slide.  Conversely, if things drag on much longer than another month, I think we could well see investor concern over how this will impact the global economy, especially if oil prices remain in the $75 – $80/bbl range, which likely means equity markets will suffer.

To the extent that anyone is still looking at data, this morning brings the ISM Services (exp 53.5) and then we see Crude Oil inventories later this morning.  The Services PMI data throughout Europe and Asia was in line with expectations showing slow growth remains the story.  Chinese data was marginally softer for large companies and marginally stronger for small companies.  As well, the Fed’s Beige Book is released at 2:00 this afternoon.

However, I don’t see data as a driver yet, so headline risk remains the biggest one out there, but the indications are markets are starting to absorb the war and move on.

Good luck

Adf

Not All in Sync

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The story that’s tripping off lips
Is whether the buildup in ships
And aircraft we’ve seen
Is likely to mean
A war with Iran’s in the scripts
 
But markets are not all in sync
As equities clearly don’t think
That war would be trouble
While bond traders’ double
Their bets war will drive stocks to drink

Economic data is clearly not a key driver of market movement these days, arguably because we continue to get mixed outcomes, with some things looking good (Initial Claims, Philly Fed) while others are less positive (Trade Balance, Leading Indicators), although granted, it is not clear to me what the Leading Indicators purpose is anymore.  My point, though, is that we have not seen unambiguous strength or weakness across the data set for several months.  This allows every pundit to frame the economic situation through their own personal lens, whether bullish or bearish.  A perfect example is the dichotomy between the strength of US corporate balance sheets, as per Torsten Slok and seen below, 

and the rise in corporate bankruptcies as per this X post from The Kobeissi Letter (a great follow on X) which shows the following chart.

So, which is it? Are things good or bad?  My understanding is that strong balance sheets and a high number of bankruptcies are not typically correlated, but I could be wrong.  

Given the lack of direction, markets have turned their focus to other things, with most headlines currently garnered by the ongoing buildup of US military power in the Middle East as President Trump tries to pressure Iran into ceding its nuclear and missile programs.  (Of course, the announcement that all information on UAP’s (fka UFO’s) has many excited, and of course, the Epstein files continue to garner attention, as does the SAVE Act, but none of those are even remotely related to financial markets.)

But even here, we are seeing very different responses by the financial markets.  For instance, equity markets continue to perform pretty well, even though Tokyo and Australia sank a bit last night.  Look at the monthly and YTD returns in Europe, Japan and Australia below:

                                           Daily   Weekly   Monthly   YTD

Source: tradingeconomics.com

It strikes me that if war was a major concern, investors wouldn’t be stocking up on risk assets.  Rather, havens would be in more demand, which we are also seeing with gold (+0.4%) and silver (+3.3%) rising overnight as despite extreme volatility in the precious metals space, there is clearly underlying demand for these havens.

Bond yields over the past month have declined, indicating that despite ongoing deficit spending, investors are seeking their perceived safety whether in Treasuries, Bunds or JGBs as per the below chart of all three.

Source: tradingeconomics.com

Finally, the dollar, despite frequent calls for its death, has been edging higher in a classic risk-off response as no matter how much some may hate the dollar philosophically, when bad things happen, its massive legal and liquidity advantages outweigh virtually everything else.  Once again, the DXY has moved back to the middle of its trading range, just below 98.00 this morning, and to my eyes, shows no signs of an imminent collapse.  Rather, if hostilities do break out in Iran, I expect the greenback to rally to at least the top of this trading range at 100, and depending on the situation, it could easily go higher.

Source: tradingeconomics.com

All this is to point out that nobody knows nothing.  Narrative writers continue to try to keep up with the action, and it is increasingly difficult to do so as things change on the ground so rapidly.  Let me be clear when I say I have zero inside information regarding any of this, I am merely an observer.  However, my observations are that there will be some type of military action in Iran as to build up this much fire power in a concentrated area and not use it would be remarkable and I can see no way in which the Ayatollah can accept the terms being offered as it would end his leadership if he does.  I guess we will find out soon enough as President Trump has put a 10-day timeline on things.

Arguably, the only market I didn’t mention here was oil (-0.5%) which is consolidating after a 20% rise in the past two months.  Remember, if military activity is directed at oil production or transport, we could see a sharp spike here and that will not help equities or economic data, although both gold and the dollar are likely to benefit.

Source: tradingeconomics.com

I don’t think there is anything else to discuss market wise so let’s turn to the data.  This morning brings a bunch of important stuff as follows:

Personal Income0.3%
Personal Spending0.4%
PCE0.3% (2.8% Y/Y)
-ex food & energy0.3% (2.9% Y/Y)
Q4 GDP3.0%
Flash Manufacturing PMI52.6
Flash Services PMI53.0
Michigan Sentiment57.3
New Home Sales730K

Source: tradingecomomics.com

We also hear from two more Fed speakers, but at this point, they are all singing from the same hymnal explaining policy is in a good place and unless there are major changes in the data, there is no reason to change.

Arguably, the PCE data is the key for markets here as if it continues to run hotter than target, hopes for further rate cuts will continue to dissipate.  In fact, the next cut is now priced in for July with a second for October.  

Source: cmegroup.com

Remember, too, at that point it will be Kevin Warsh’s Fed, not Jay Powell’s, and Warsh has a very different idea about the way things need to be done.  Interestingly, as this 4th Turning proceeds and old institutions come under increasing pressure, their efforts to fight back and maintain the status quo is no longer behind the scenes as evidenced by this Bloomberg article this morning.

As I have written before, President Trump is the avatar of the 4th Turning and the institutions that are going to change are desperate to maintain the status quo.  This is, truly, the big fight that will continue through the end of the decade in my view.  Every institution that has been overseeing the global situation, whether politically, financially or militarily, is coming under pressure as income and wealth inequality have driven an ever wider disparity of outcomes.  As much power as the rich have, there are a lot more people who are not rich.  Ask Louis XVI how much being rich helped him.

On a lighter note, I watched the gold medal skating performance of Alysa Liu and it was truly magical.  A much better thought for the weekend!

Good luck and good weekend

Adf

Quite Gory

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While yesterday, there was one story
‘Bout silver and gold and their glory
By end of the session
The dollar’s depression
Was headlining comments quite gory
 
The narrative now speaks of trends
Which lead to a dollar that ends
The problem they’ve got
Is history’s taught
That cycles and dollars are friends

The dollar is clearly under pressure lately as discussed here yesterday morning.  Using the DXY as our proxy, it has traded and closed through the recent double bottom (see chart below), and the doomsayers are licking their chops that their views of the demise of the dollar are finally coming to fruition. 

Source: tradingeconomics.com

And I am not here to say the dollar is about to reverse course higher.  While I remain medium and long-term bullish on the buck, it doesn’t feel like the time to get long.  However, look at the chart below, to get a longer-term perspective on the dollar’s history.  This chart starts back in 1985, which is just before the Plaza Accord where it was agreed the dollar was too strong and central banks around the world intervened and altered policy to change it.  But here we are at 96ish in a market that has spent no little time below 80 with several drops below 75.  My point is, the dollar tends towards long cycles.  It is entirely possible that we peaked in late 2022 for this cycle and are now heading lower from there.  But I remain highly confident that it will reverse course and rebound. Not tomorrow, but this is not the end.  Just remember that when you read the eulogies for the buck.

Source: finance.yahoo.com

One other thing that seems to be getting headlines is that the president was asked his views on the dollar’s recent weakness and was (rightly) nonplussed over the issue as described here.  After all, this is a man who constantly rails against the artificial weakness of the yen and the yuan, and who is seeking to rebalance the trade account.  All that points to a weaker dollar, so it beggar’s belief that this is a surprise to the market.

One last thing while I’m on my high horse.  I couldn’t help but notice this article about Banque de France chief Villeroy explaining that the weakening dollar may impact ECB policy-making with a throwaway line about diminishing confidence in the dollar stemming from the unpredictability of US economic policy.  First off, US policy is very clear, run it hot!  And second, it is remarkable that when the euro was tumbling, we never saw this same introspection about Eurozone/EU economic policy and their self-destructive energy policies.  My point is, nothing we are currently witnessing is new in any way at all, but rather part of the longer-term cycle of FX markets.

OK, how has this dollar move impacted other markets?  Well, yesterday’s US equity session was marked by a rotation back to tech as the NASDAQ (+0.9%) had a fine day while the DJIA (-0.8%) fell hard.  This led to a mixed session in Asia with the Nikkei little changed (although other indices there were under steady pressure), while HK (+2.6%) exploded higher on news that China has licensed its first Nvidia H200 chips to Alibaba and someone threw money at China Vanke, one of the collapsing Chinese real estate firms.  The mainland was modestly higher (+0.25%) but there was strength in Korea (+1.7%), Taiwan (+1.5%) and India (+0.6%).  On the downside, Indonesia (-7.3%) tumbled after MSCI indicated they may downgrade the market there to frontier status due to lack of liquidity.

In Europe, red is today’s color led by Spain (-1.1%) and France (-1.0%) with the latter seeing weakness in luxury stocks while the former appears to be unwinding some of its recent strength with no particular catalyst, merely a negative view overall in Europe.  Germany (-0.2%) and the UK (-0.4%) are also softer without anything specific.  As to US futures, at this hour (6:40) they are pointing higher with NASDAQ (+1.1%) leading the way again.  As an aside, the S&P 500 futures are above 7000 now, and the cash market looks set to break that big round number this morning.

In the bond market, as we await the FOMC policy decision (no change expected) and the subsequent press conference, Treasury yields are unchanged this morning after having edged higher by 2bps yesterday.  European sovereign yields are all basically softer by -2bps, perhaps on the back of the euro’s strength.  After all, Villeroy hinted that if the euro remains strong, they may need to cut rates again.  Interestingly, JGB yields (-5bps) fell after BOJ Minutes from the December meeting (remember, they already met again last week) indicated that some members were concerned over the weaker yen driving inflation higher.  Talk about stale news.  My sense here is this is much more about the election and JGB’s will track Takaichi-san’s support level with lower yields coincident with weakening support, potentially preventing her Liz Truss moment.

In the commodity space, oil (0.0%) is unchanged this morning but has rallied more than 7% in the past month after a solid session yesterday.  Looking at the chart, the trend clearly remains lower, but the short-term reversal is also quite clear.

Source: tradingeconomics.com

The dollar’s recent weakness is supporting all commodities (given they are generally priced in USD, other nations can afford more with the dollar’s slide), but the bigger picture remains that there is an extraordinarily large amount of the stuff around and much of the angst over its recovery is political (look at Europe) rather than geologic.  Nat Gas (-4.5%) is backing off its extended levels as temperatures are forecast to rebound early next week (cannot happen soon enough for me, where’s global warming when you need it?), but the long-term story here remains positive as it continues to be the energy source of choice for timely access with the least environmental impact.

Turning to metals, gold (+1.6%) continues to trade to new highs on the ‘all of the above’ thesis (weak dollar, debasement trade, geopolitical risk, central bank buying) and shows no signs of slowing down.  Silver (-0.1%), however, has been so incredibly volatile it is starting to become a concern for all involved.  It is not normal for 10%-12% daily moves in any product, let alone one with so much involvement from both retail and institutional players.

Source: tradingeconomics.com

The silver market has gone into backwardation which means that there is significant demand for the actual metal.  And prices in Shanghai trade at a significant premium to the COMEX.  Shanghai is a delivery market.  We will need to watch deliveries at futures expirations closely going forward.

Finally, the dollar today is bouncing off yesterday’s session lows but remain under pressure overall.  After trading through 1.20 yesterday, the euro (-0.6%) has backed off a bit and we have seen similar moves through much of the rest of the G10 (GBP -0.6%, SEK -0.7%, NOK -0.7%, CHF -0.9%).  The yen (-0.3%) continues to be caught between potential intervention fears and fears of unfunded spending.  In the EMG bloc, we have seen CE4 currencies all suffer on the order of -0.7% or so, although APAC currencies are little changed this morning.  The one currency bucking the trend is CLP (+0.2%) which remains closely connected to copper (+1.0%).

On the data front, yesterday’s Consumer Confidence Index fell sharply, a further indication that there is a split between most of the economic numbers and people’s beliefs.  Today, aside from the Fed, we hear from the BOC (no change expected) and we get EIA oil inventories with a small draw forecast after several weeks of large builds.  Too, later in the day the Banco do Brazil will announce their policy (no change expected).

The thing that makes me happy is the Fed is an afterthought today.  While the cacophony of noise that comes from media is extremely difficult to parse given the biases underlying almost all one reads or hears, to me, the question will be whether people start to believe things are getting better, and that is more political than economic in my view.  In the meantime, the dollar appears to be set for a bit of further weakness, but do not mistake this for the end of the dollar or the dollar’s role in the global economy.

Good luck

Adf

Much Ado

Posted on by

The market response to the raid
In Vene has so far been staid
The black, sticky goo
Despite much ado
Shows traders have not yet been swayed
 
And frankly, that seems to make sense
‘Cause years will pass ere they commence
To pump much more oil
But that shouldn’t spoil
The truth their reserves are immense

 

As of 9:00 last night, oil futures are essentially unchanged from Friday’s, pre-Venezuelan news, close.  As you can see from the chart below, while there was an early blip higher of about 50¢, that quickly retraced.

Source: tradingeconomics.com

But, stepping back a bit, a look at the chart for the past year shows a very steady decline in the price and at this point, there seems to be little that will change that result.

Source: tradingeconomics.com

I have consistently made the case that oil supply exists all over the world, and that politics has been the chokepoint.  Arguably, a new government in Venezuela has just removed one of those chokepoints, although from everything I can gather, given the decrepit state of the oil infrastructure in Venezuela after nearly 20 years of Socialist neglect, it will take quite a while to hit the market.  But Guyana and Argentina are going to be growing their output considerably going forward, so, a slower rate of production here ought to not matter much.

One other thing I did read was that a key driver of the weekend’s events was growing concern by the US military that the Chinese were going to monopolize rare earth mining and processing from areas of southern Venezuela and that was too great a concern.  Even if the timeline is long, it appears, at this stage, that the future of Venezuela’s oil production should start to trend higher, and that will simply add to pressures on prices.  After all, we know that markets are forward looking.

One last thing to note is that acting president of Venezuela, Delcy Rodriguez, has called for “cooperation” with the US going forward, a very different tone than her initial comments of outrage.  Perhaps she has figured out that this is a sweet deal for her, or perhaps she is simply afraid that she is not safe if she doesn’t cooperate.  Whatever the reason, I suspect that things will progress positively from here.

In the meantime, let us try to turn our attention elsewhere, although it will be difficult as this action will clearly have many widespread, and at this point unforeseeable, impacts on markets other than oil.  But try we must.  With that in mind, let’s review markets overnight and see how the initial price action has evolved, and perhaps what it implies for the future.

Starting with equities, you’re hard pressed to find a market anywhere in the world that is suffering this morning despite the alleged increase in uncertainty.  In fact, it appears that investors are pretty certain that today is a better day than Friday was given the new world order that is developing.  Starting in Asia, the only market that fell overnight was India (-0.4%) seemingly on the idea that one source of their cheap oil may have been stopped.  But elsewhere, Japan (+3.0%), China (+1.9%), Korea (+3.4%) and Taiwan (+2.6%) all had extremely strong sessions with HK, Australia and other smaller exchanges showing little to no gains.  My only surprise here is China, which has invested significantly in Venezuela, lent them large sums of money and also had their advanced radar systems shown to be useless against US military aircraft.  But in the end, fear was not on the agenda in Asia.

What about Europe?  Well, here things are less excitable, with Germany (+0.65%) and Italy (+0.6%) the leaders as defense firms in both nations have performed well this morning.  But otherwise, Europe is a nonevent this morning, which given their increasing global irrelevance, should be no surprise.  The UK, France, and Spain have all barely moved and surprisingly, Switzerland (-0.7%) has fallen, although perhaps neutrality is not such a benefit anymore.  US futures, though, are continuing their ride higher with the NASDAQ (+0.8%) leading the way in a sea of green.    The net result here is, risk is still in vogue.

Turning to the bond market, only JGB yields (+6bps) are rising after PM Takaichi reiterated her call for more spending.  Yes, this is a new 29-year high in 10-year JGB yields, but I suspect they have further to go.  After all, as you can see from the below chart, yield suppression has been the game there for decades, so unwinding it will take some time.

Source: investing.com

But elsewhere in the fixed income world, yields are slipping across the board.  Treasury yields (-3bps) are leading the way with all of Europe seeing declines between -2bps and -3bps.  I might suggest this is a response to the prospect of declining oil and energy prices going forward, even though it will take time to see the increases in production.

As to commodities, as of this morning at 7:30, oil has bumped up 0.5%, although as you can see in the above chart, remains in a longer-term downtrend that shows no signs of breaking soon.  Metals, meanwhile, remain the story of stories with the entire periodic table looking good (Au +1.9%, Ag +3.3%, Cu +2.9%, Pt +2.5%).  I continue to read about reasons as to why this rally in metals is going to end soon, with most focused on the speed of the ascent last year.  But the difference in this market vs. any paper financial market is, physical supplies matter here, and by all accounts, Ag, Cu and Pt are all in short supply for their industrial uses (think catalytic converters for Pt) and as industrial users recognize the shortage, they continue to bid up the price.  While I expect all these markets to remain volatile this year, I suspect that the trend higher has a lot of runway yet.

Finally, the dollar is firmer this morning, despite the rally in metals.  The euro (-0.3%) is the laggard in the G10 space as the EU was shown to be completely powerless, useless and irrelevant over the weekend.  However, they did issue a carefully considered statement to cement the idea that they are powerless, useless and irrelevant as seen below.

I know I feel safer now!  In addition to this demonstration, the timeline for a digital euro seems to be speeding up, a decision that will further undermine the single currency in my view.  Nothing has changed my opinion, except perhaps strengthening it, that the world is going to bifurcate into USD stablecoins and digital CNY over the next few years, with most of Europe opting for USD.  Elsewhere in the G10, movement has been less pronounced, +/-0.2% or less with nothing of note to mention.  In the EMG bloc, most of the currencies here are a bit weaker, -0.3% or so, with two key exceptions, ZAR (+0.1%) and CLP (+0.2%), both benefitting from the large gain in the metals complex.  Interestingly, MXN (-0.35%) is amongst the worst performers as the natural thought process seems to be, is President Sheinbaum next unless she effectively shuts down the cartels.  I keep searching for reasons to understand bearishness on the dollar but have yet to find any that make sense.  One other thing to note, there has been a resurgence in the discussion of how the dollar is losing its traction amongst central banks with respect to reserves held.  Many are highlighting that the percentage of reserves in USD has fallen to its lowest level since the mid 1990’s.  but a look at the chart below shows that while the recent trend has declined, it remains far above its lows, and far below its highs over time.  In fact, one might say it’s right in the middle of the range.

Turning to the data this week, with the government having been back in action for a while, we are back to a full slate of data for the first week of a month.

TodayISM Manufacturing48.3
 ISM Prices Paid59.0
TuesdayPMI Services52.9
 PMI Composite53.0
WednesdayADP Employment45K
 ISM Services52.3
 JOLYs Job Openings7.64M
 Factory Orders-1.2%
 -ex Transport-0.3%
ThursdayInitial Claims216K
 Continuing Claims1851K
 Trade Balance -$58.4B
 Nonfarm Productivity3.0%
 Unit Labor Costs1.0%
 Consumer Credit$10.2B
FridayNonfarm Payrolls55K
 Private Payrolls60K
 Manufacturing Payrolls-5K
 Unemployment Rate4.5%
 Average Weekly Hours34.3
 Average Hourly Earnings0.3% (3.6% Y/Y)
 Participation Rate62.6%
 Housing Starts (Sept)1.31M
 Building Permits (Sept)1.35M
 Michigan Sentiment53.2

Source: tradingeconomics.com

While some data remains stale (housing), the jobs data is December’s and will get a great deal of attention.  One thing to remember here is that if the deportation numbers discussed by the government are correct (~500K actual deportations and ~2.0MM self-deportations), then the economy doesn’t need to create that many new jobs to keep things ticking along.  I have seen estimates of somewhere between 0 and 20K jobs each month being sufficient to keep the Unemployment Rate steady to declining.  I am sure, however, this issue will be the subject of much discussion by the economics community going forward, but as I have said time and again, the models in use today do not seem to reasonably represent the reality today.  Expect a lot of huffing and puffing about this data, largely along political lines.

And that’s really it.  Obviously, Venezuela has changed a lot of calculations about many markets, but in the end, while I remain concerned over an eventual risk-off outcome, I don’t see that as an immediate threat.  Remember, too, the OBBB has taken effect and tax situations are going to be changing now, something that will undoubtedly help the economic data going forward.

Good luck

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A Vision For ‘Twenty-Six

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(With apologies to Clement Clarke Moore)

Tis the first day of trading in Ought Twenty-Six
With too much attention on raw politics
At home, eyes have turned to the mid-term elections
To see if results will force mid-course corrections
In Europe, they’re going all-in on Ukraine
With more billions promised, though that seems insane
Meanwhile, Mr Xi is convinced he can fix
The problems at home with his policy mix
And this, my friends, just skims the surface of things
As pols everywhere suffer arrows and slings
Remember, though, markets are what I’m about
And while I could err, I am never in doubt.

Let’s start at the top with Growth here in the States
Which likely will show more than marginal rates
In fact, Four percent seems a viable goal
As inward investment and tax cuts take hold
Remember, for Trump, if there’s one thing he’s not
It’s timid, and so he’ll demand, “Run it hot!”
Thus, growth will expand, though inflation might gain
And for the elections, that could be a pain
The problem is Jay, and whoever comes next
Have come to believe two percent’s just subtext
The greatest unknown is on government spending
And whether it grows or, at last, starts descending

The punditry’s certain the government fisc
Is going to increase inflation’ry risk
If true, CPI of near Four percent’s apt
If not, then Inflation ‘neath Three, could be capped

And what about elsewhere, in Europe? Japan?
In markets, emerging, do they have a plan?
Will they grow their ‘conomies, drawing investment?
Or will we soon witness a large reassessment?

In Europe, they claim they’ll be building more guns
To help them defend all their daughters and sons
As well, they’re committed to helping Ukraine
Continue to fight, despite so many slain
They’re planning to borrow a cool 90 Bill
But energy costs, these grand plans could well kill
Meanwhile, M Lagarde claims that rates are just right
And given growth there’s One Percent, I won’t fight
So, weak growth and low rates and energy blues
Lead me to believe that come year-end, the news
Will be that the Euro is failing to thrive
Do not be surprised when it hits One oh-Five

In England and Scotland and all the UK
Just like in the EU, they can’t make much hay
The budget’s a wreck yet they want to raise taxes
Though history shows growth will wane ere it waxes
As well, they continue their crack down on speech
While crimping their energy industry’s reach
So, power is costly, and billionaires flee
From here, ‘cross the pond, this is what I foresee
A ‘conomy heading right into stagflation
As long as Kier Starmer is leading the nation
For markets, the Pound will lose all its allure
With One-Ten the Boxing Day screen price du jour

A turn to the East where the Sun Also Rises
Will teach us that, really, there are no surprises
To date you’ve heard much ‘bout the rise in yen rates
With pundits opining the Carry Trades’ fates
This year, so they say, look for much stronger yen
As local investors buy yen bonds again
Thus, all the hedge funds who’ve been funding their trades
By borrowing yen, and they’ve done so in spades,
Will need to buy back all that Japanese Money
The outcome, for yen shorts, will not be so sunny
But what if this idea of yen heading home
Is wrong?  This implies quite a different syndrome

At this point there’s no sign the government there
Is ready, more spending and debt, to forswear
Instead, what seems likely is more of the same
More government spending in all but its name
So, debt will continue to rise without end
And up to One-Eighty the buck will ascend

As well as Japan, in the continent vast
Of Asia, it’s China we come to at last
“Poor” President Xi has a problem at home
Consumption is not in the Chinese genome
For decades, the model’s been, build and export
Which helps explain why local usage falls short
But lately the rest of the world’s of a mind
That Chinese imports are a troublesome kind
So, Xi needs his people to learn how to spend
Else all that production may come to an end
But if they consume, what will that do to growth?
Its rate will decline, something for which Xi’s loath

Thus, GDP 5 means a weaker yuan
Well above Seven you can depend on
But if, against odds, Xi gets Chinese to spend
Six-Fifty is where yuan will be at year end.

Let’s shift our perspective to Treasury debt
A market of critical import, and yet
A market that’s been in a range for a while
So, what must occur for a change in profile?
The popular view is that deficit spending
Will drive an outcome of, high yields, never-ending
But Trump and his team are, quite hard, pushing back
Explaining that policy’s on the right track
Twixt tariffs and growth, tax receipts have been flying
While RIFs in the government are underlying
The idea that deficits soon will be shrinking
In truth, this is not what the punditry’s thinking
But one thing is clear that will keep yields from climbing
QE, which is back, is designed for pump-priming
So, Jay and his heir will keep buying and buying
And 10-Years at Four Percent seems satisfying

It’s not just the government, though, that’s in debt
Those corporates who borrowed at ZIRP, have not yet
Refinanced the trillions they owe, to this day
And now they’re competing with Bessent and Jay
While Scott will find buyers, if not least the Fed
For corporates that path may be flashing bright red
If credit spreads widen will companies fail?
And will that unravel the stock markets’ tale?
Right now, spreads for IG sit near one percent
And Junk’s above eight with investors content
However, the biggest risk this year could be
The absence of corporate debt liquidity
If IG spreads widen 200 bps more
The outcome could be a GFC encore

This takes us to stocks, both at home and abroad
Which last year saw rallies we all did applaud
But will this year bring us some more of the same?
Or have things been altered?  Is there a new game?
If my crystal ball is in any way clear
The outcome could well be a frightening year
Remember, the driver of last year’s returns
Was government spending which lacked all concerns
Thus, Cantillon nailed it with where cash would go
And stocks were the winner, of that much we know
But this year the mountain of debt coming due
Could well force decisions of what will ensue
And too, don’t forget if the deficit shrinks
It’s likely to be a great stock market jinx
So, don’t be surprised if December this year
A 10% fall ‘cross all stocks does appear

And what of that black, sticky stuff that they drill
Which powers the global economy still
When its price increases, it causes much pain
For most everyone, it can be quite the bane
Consumers, instead, like those prices to sink
But drillers, in that case, cause output to shrink
So, which will it be, will Trump’s mantra come true
Or will, new production, most drillers eschew
I think what is missed is technology’s traction
And how costs per barrel will tend toward contraction
As well, nations worldwide, at last understand
That Carbon Dioxide just cannot be banned
Come Christmas, next, we will see growth in supply
With Fifty per barrel the price we’ll espy

The last place to look is at bright things that shine
Which saw prices move in a vertical line
While gold was the starter, by year end t’was clear
That silver and platinum said, wait, hold my beer
The latter two rising thrice fifty percent
With neither responding to any event
Which brings us to this year, can these trends maintain?
Or are we now set up for infinite pain?
It seems to me that til the summer at least
All three will continue to rise, as with yeast
But when we reach solstice do not be surprised
If views on their future become bastardized
In other words, look for corrections in price
With early year gains given back in a trice
But still, by the end of the year I believe
Five Thousand in Gold is what we will perceive
For Silver, One Hundred could well be the spot
And Platinum, Three Grand, would not be too hot.

To all of my readers and friends, please forgive
My musings if they got too ruminative
This year will see change across many degrees
And some will be painful, while others will please

In sum, I think President Trump can succeed
In changing behavior, though not corporate greed
Reducing the number of government staff
As well as with regs, he can cut those in half
Inward investment will focus on stuff
Instead of on stocks, for the markets that’s rough
Dollars will still be in greater demand
While Treasury yields will be stuck in the sand
IG and Junk are unlikely to win
As rising expenses cut margins quite thin
And still, through it all, precious metals will gain
Though G7 central banks all will abstain
Come Christmas next, nothing will look quite the same
And maybe my views can help you build a frame.

Thank you all for tolerating my punditry and I hope that you all have a wonderful, healthy and successful year ahead.

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Real Savoir Faire

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There once was an aging Fed Chair

With poise and some real savoir faire

He claimed the foundation

Of rising inflation

Were objects that, right now, were rare

But soon when supply chains are mended

And joblessness falls as intended

Inflation will sink

To levels we think

Are fine, and the world will be splendid

Remember when the FOMC Statement and following press conference were seen as hawkish?  That was sooo last week!  There was talk of rate hikes in only TWO YEARS!  There was talk about talk about tapering the purchase of assets as monetary policy started to ‘normalize’.  (Not for nothing but given we have had the same monetary policy for effectively the past 13 years, ZIRP and QE might be considered normal now, not positive real rates and a stable balance sheet.)  Well, apparently the market reaction was not seen as appropriate by Chairman Jay and his cadre of central bankers, so we have heard a definitive retreat on those concepts in the ensuing six days.  

Just since Monday, we have heard from six different FOMC members and every one of them has essentially said, “just kidding!”  Yesterday, Chairman Powell testified to a House Subcommittee on Covid and was forced to explain, yet again, that policy changes were still a long way down the road and that inflation remains transitory.  It was not, however, just Powell delivering that message.  It was also Cleveland’s Loretta Mester, SF’s Mary Daly and NY’s John Williams amongst others.  Current policy settings are appropriate, inflation is transitory and there is still a long way to go before that elusive substantial further progress toward the Fed’s dual mandates will have been achieved.

History has shown that the Fed’s effective reaction function, at least since Alan Greenspan was Chair, is defined by an equity market decline of a certain amount.  This is especially true if the decline happens quickly whereupon they will jump in and ease policy.  It appears that the amount of market angst necessary to get the Fed to change their tune regarding infinite liquidity and monetary support continues to shrink.  It used to take a decline on the order of 15%-20% to get the Fed nervous.  This time, the S&P 500 fell less than 2% before virtually the entire committee was on the tape walking back their tough talk.  And yet, they would have you believe that when inflation is roaring higher for the rest of the year, they have the intestinal fortitude to fight it effectively by raising interest rates or reducing QE.  As actions speak louder than words, my money is on the Fed being completely unable to address rising inflation.  Be prepared.

This topic continues to be the primary narrative in markets around the world, with many other countries now grappling with the transitory inflation story as well.  Nothing else really matters, and rightly so.  If inflation is building a head of steam and will be rising around the world, central banks are going to be forced to respond.  Some will respond more forcefully and more quickly than others, and it is those currencies which are likely to outperform going forward.  Investors today are generally unfamiliar with investing in an inflationary environment.  The 1970’s were the last time we really saw inflation of substance and even I was still in college (and I am almost certainly much older than you) when that was the situation, with many, if not most, of the current investment community not yet even born.

A quick look at the chart of the Dollar Index (DXY) from that time shows that from the autumn of 1971, right after President Nixon closed the gold window and ended Breton Woods, through the end of 1979, right after Paul Volcker was named Fed Chair and had just started his inflation fight, the dollar declined about 28% (roughly 4% per annum).  Of course, once Volcker got going and US interest rates were raised dramatically to kill off inflation, the dollar rose more than 75% in the following four years.

The point is that while we may disparage the Fed’s actions as being wrong-headed, their policies matter immensely.  Jay Powell may wind up with his reputation in tatters akin to Arthur Burns and G. William Miller, the Fed Chairs who oversaw the sharp rises in inflation in the 1970’s preceding Mr Volcker.  It seems unlikely this outcome is his goal, however, his insistence on toeing the political line rather than hewing to sound money policies bodes ill for the future.

Anyway, while US equity markets have essentially retraced all their post FOMC losses, the rest of the world has seen a more mixed outcome.  In Asia last night, the Nikkei (0.0%) was essentially flat although there were gains in the Hang Seng (+1.8%) and Shanghai (+0.25%).  Europe, on the other hand, is under some pressure this morning with both the DAX (-0.5%) and CAC (-0.4%) feeling some pain based on softer than expected, though still strong, Flash PMI data.  The UK, however, is seeing a much better performance (FTSE 100 +0.35%) as not only was the PMI data stronger than expected, but there apparently is a breakthrough on the lingering Brexit issues of treating goods in Northern Ireland.  Meanwhile, US futures are essentially unchanged this morning, perhaps waiting for some more encouragement from today’s roster of Fed speakers.

Bond markets, after a very choppy few days, have calmed down greatly with Treasuries (+1.2bps) softening a bit while European sovereigns (Bunds -1.4bps, OATs -1.4bps) are seeing some demand.  UK Gilts are little changed as the market there awaits tomorrow’s BOE meeting, where some believe there is a chance for a more hawkish tilt.

Commodity prices are definitely firmer this morning led by oil (+0.7%) but also seeing strength in precious metals (Au +0.25%, Ag +0.7%), base metals (Cu +0.7%, Fe +1.4%, Sn +0.2%) and agricultural products (Soybeans +0.5%, Wheat +1.2%, Corn +0.4%).  Clearly the commodity markets see inflation in the future.

Finally, the dollar is mixed this morning but, in truth, the relatively small movements indicate a lack of interest.  Commodity currencies like NOK (+0.1%), AUD (+0.2%) and NZD (+0.2%) are the leading G10 gainers while JPY (-0.35%) continues to come under pressure, arguably suffering from the fact that Japan imports virtually all its commodities.

In the EMG space, the picture is also mixed with HUF (+0.7%) the leading gainer after the central bank raised its benchmark rate to 0.9% yesterday a 0.3% increase that was expected.  But the idea that they are joining the several other EMG central banks in tightening mode (Brazil, Russia, Ukraine) has investors buying up the forint.  Away from that, ZAR (+0.4%) is clearly benefitting from higher commodity prices as are RUB (+0.2%) and MXN (+0.1%) although the latter two are quite modest.  On the downside, KRW (-0.5%) saw the sharpest declines as a combination of equity outflows as well as a sharp rise in Covid infections was seen quite negatively.  But in truth, most APAC currencies were under some pressure overnight, albeit not to the extent seen in Seoul.

Today’s data brings the Flash PMI (exp 61.5 Mfg, 70.0 Services) as well as New Home Sales (865K).  But more importantly, we have three more Fed speakers set to reiterate the message that policy is not going to change for a while yet, so no need for investors to panic in any market.  The dollar responded logically to the idea that the Fed was going to tighten policy, but now that they have gone out of their way to walk that idea back, I expect the dollar is more likely to drift lower for now.  Perhaps when it becomes clearer that the Fed is actually going to move, we could see some strength again.  But that is likely still a few weeks or months away.  Trade the range for now.

Good luck and stay safe

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Getting Upset

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The Chinese are getting upset

Commodity prices, as yet

Continue to rise

As shrinking supplies

Now pose, to their model, a threat

So, naturally, what did they do?

They ordered state firms to eschew

Stockpiling provisions

As now all decisions

Will come from Beijing ‘pon review

With the FOMC meeting on virtually everyone’s mind this morning, market activity overall has been muted.  However, the one place in the world that doesn’t revolve around the Fed is China, and news from there last night is quite interesting.  You may recall my quick story about the Department of Price two weeks’ ago and how that ‘august’ institution warned commodity hoarders and speculators to stop what they were doing.  Well, apparently, not enough people listened to those warnings as last night two more Orwellian entities in China joined the conversation regarding commodity prices.  The State-owned Assets Supervision and Administration Commission (SASAC) ordered companies under its purview, the SOE’s, to “control risks and limit their exposure to overseas commodities markets”.  This was clearly the stick to accompany the carrot dangled by the National Food and Strategic Reserves Administration, which has indicated it will soon release state stockpiles of copper, aluminum and zinc amongst other metals.

It is obvious that China has figured out that rising commodity prices may soon start to pass through from the factory to the consumer and drive CPI higher on the mainland.  President Xi is clearly concerned that rising prices could lead to some political unrest given that the bargain he has made with his citizens is to enhance their lives economically so he can control all the levers of power.  Thus, if inflation starts to rise more seriously, the population may call his leadership into question.

The problem for China, however, is that while in the past, they had been the marginal buyer of virtually all commodities as they grew their economic capacity dramatically, that situation no longer holds.  Yes, they still have an impact, but in this post-Covid environment where the rest of the world is rebounding very quickly, demand for commodities outside of China is growing rapidly.  But perhaps more importantly, because the previous decade saw commodity prices lag financial prices, investment in the sector was greatly reduced.  This has led to reduced supplies of many critical things and now that demand is resurgent, not surprisingly the prices of copper, steel and other commodities have been rising rapidly even if China isn’t buying as much as they used to.

Adding to this dynamic is the great conundrum of ESG.  On the one hand, ESG’s goals are to reduce environmental impact of economic activity which has largely played out as trying to substitute electricity for fossil fuels as a power source.  On the other hand, in order to electrify economies, the amount of metals like steel and copper required to achieve the stated goals is dramatically higher than the current model.  So, reducing investment in commodity producers results in much higher prices for the very commodities needed to achieve ESG goals in the long run.  While this is not the only argument to rebut the Fed’s transitory inflation story, it is an important part of the inflationists’ views.  China’s actions will only have a very temporary impact on the prices of the commodities in question, but the long-term demand is here to stay.  Until investment in extraction of commodities increases sufficiently to bring more capacity online, odds are that commodity prices will continue to rise, whether Xi Jinping likes it or not.  And if input prices continue to rise, at some point soon, so will prices of end products.  We have been witnessing the beginnings of that trend, but I fear it has much further to go.

Interestingly, despite all the sturm und drang in Beijing about metals prices, after a sharp decline yesterday, this morning they are edging higher (Cu +0.2%, Al +0.1%, Fe +0.5%, Steel +2.8%) although not nearly reversing yesterday’s moves.  If you ever wanted proof that China no longer calls the shots in commodities, here is exhibit A.

Today Chairman Jay will expound

On growth and its stunning rebound

But do not expect

That he will project

Some changes will shortly gain ground

The other story today, really the biggest for our session, is the FOMC meeting.  Broadly speaking, expectations are that the Fed will not make any policy changes of note, although there will clearly be some tweaking to the statement.  They cannot ignore the 5.0% CPI reading, I think, and they will certainly focus on the idea that the employment situation isn’t improving as rapidly as they would like.  And ultimately, for now, it is the latter issue that will continue to inform policy choices.  So tapering is not going to be on the menu, and when Powell is asked in the press conference, as he surely will be, I expect a response along the lines of, substantial further progress needs to be made before they will change things.

If I were to assess the risks, it feels like there is more risk of a hawkish outcome than a dovish one as the inflation story will not go away.  But that implies to me that the market is according a hawkish twist some real probability, so the big surprise to markets would be if they were excessively dovish.  However, I think Powell will do everything he can to be as nondescript as possible, stay on message and there will be very little movement.

A brief recap of markets overnight shows that Asian equities suffered, led by Shanghai (-1.1%).  Not only are they dealing with rising commodity prices, but the data released (Retail Sales, IP and Fixed Asset Investment) all disappointed vs. expectations.  China’s negativity bled into the Nikkei (-0.5%) and Hang Seng (-0.7%) as well.  Europe, on the other hand, has gone nowhere ahead of the Fed, with virtually every equity index within 0.1% of yesterday’s closes.  It should be no surprise that US futures markets are also essentially unchanged ahead of the Fed.

As to the bond market, we are beginning to see a touch of strength with yields declining ever so slightly.  Treasuries are lower by 0.5bps, while Bunds (-1.1bps), OATs (-0.9bps) and Gilts (-0.7bps) are also performing reasonably well ahead of this afternoon’s announcements.  It remains remarkable to me that with inflation rising universally, bond yields continue to ignore the situation.  One has to give credit to the central banks for selling their transitory story.

In the FX markets, the picture is mixed with gainers and losers evenly split in the G10.  AUD and NZD (+0.3% each) lead the way higher, although there does not appear to be a clear catalyst implying this is a positioning issue.  GBP (+0.25%) has gained on the back of slightly higher than expected CPI readings (2.1% vs. 1.9% expected), as traders look for more concrete tightening of policy there.  On the downside, both NOK and SEK have fallen by 0.35%, despite oil’s modest gains and a lack of other news.  Again, this feels more technical than fundamental.

EMG currencies are also little changed overall, with a touch of weakness seen in the APAC bloc overnight, but only on the order of -0.1%, while RUB (+0.3%) and MXN (+0.25%) are the leaders, clearly helped by oil’s ongoing gains, but also seeming to benefit from some political stories.

Data this morning bring Housing Starts (exp 1630K) and Building Permits (1730K), but they will not be noticed with the Fed story coming later this afternoon.  Yesterday’s data was mixed at best with Retail Sales disappointing for May but seeing large positive revisions in April to offset, while PPI once again printed at much higher than expected levels (6.6%).  But let’s face it, today is Fed day and we are unlikely to see much movement until at least 2:00 when the statement is released if not until 2:30 when Chairman Powell starts to speak.  At this time, any hawkishness is very likely to support the dollar with the opposite true as well, a dovish tilt will lead to a dollar decline.

Good luck and stay safe

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Out of Gas

Posted on by 
Though prices are forecast to rise
The Treasury market implies
That Jay has it right
And this is the height
Inflation will reach at its highs

Instead, once the base effects pass
Inflation will run out of gas
So there is no need
For Powell to heed
The calls to halt QE en masse

This morning we finally get to learn about two of the three potential market catalysts I outlined on Monday, as the ECB announces their policy decision at 7:45 EDT with Madame Lagarde speaking at a press conference 45 minutes later.  And, as it happens, at 8:30 EDT we will also see the May CPI data (exp 0.5% M/M, 4.7% Y/Y headline; 0.5% M/M, 3.5% Y/Y ex food & energy).  Obviously, these CPI prints are far higher than the Fed target of an average of 2.0% over time, but as we have been repeatedly assured, these price rises are transitory and due entirely to base effects therefore there is no need for investors, or anybody for that matter, to fret.

And yet…one cannot help but notice the rising prices that we encounter on a daily basis and wonder what the Fed, and just as importantly, the bond market, is thinking.  Perhaps the most remarkable aspect of the current inflation discussion is that despite an enormous amount of discussion on the topic, and anecdotes galore about rising prices, the one market that would seem to be most likely to respond to these pressures, the Treasury market, has traded in exactly the opposite direction expected.  Yesterday, after a very strong 10-year auction, where the coverage ratio was 2.58 and the yield fell below 1.50%, it has become clear that bond investors have completely bought into the Fed’s transitory story.  All of the angst over the massive increases in fiscal spending and huge growth in the money supply have not made a dent in the view that inflation is dead.

Recall that as Q1 ended, 10-year yields were up to 1.75% and forecasters were falling all over themselves to revise their year-end expectations higher with many deciding on the 2.25%-2.50% area as a likely level for 10-year yields come December.  The economy was reopening rapidly and expectations for faster growth were widespread.  The funny thing is that those growth expectations remain intact, yet suddenly bond investors no longer seem to believe that growth will increase price pressures.  Last week’s mildly disappointing NFP report is a key reason as it was the second consecutive report that indicated there is still a huge amount of labor slack in the economy and as long as that remains the case, wage rises ought to remain capped.  The counter to that argument is the heavy hand of government, which is both increasing the minimum wage and paying excessive unemployment benefits thus forcing private companies to raise wages to lure workers back to the job.  In effect, the government, with these two policies, has artificially tightened the labor market and historically, tight labor markets have led to higher overall inflation.

The last bastion of the inflationists’ views is that the recent rally in Treasuries has been driven by short-covering and that has basically been completed thus opening the way for sellers to reemerge.  And while I’m sure that has been part of the process, my take, also anecdotal, is that fixed income investors truly believe the Fed at this time, despite the Fed’s extraordinarily poor track record when it comes to forecasting literally anything.  

As an example, two weeks ago, I was playing golf with a new member of my golf club who happened to be a portfolio manager for a major insurance company.  We spent 18 holes discussing the inflation/deflation issue and he was 100% convinced that inflation is not a problem.  More importantly, he indicated his portfolio is positioned for that to be the case and implied that was the house view so his was not the only portfolio so positioned.  This helps explain why Treasury yields are at 1.49%, 25 basis points lower than on April 1.  However, it also means that while today’s data, whatever it is, will not be conclusive to the argument, as the summer progresses and we get into autumn, any sense that the inflation rate is not heading back toward 2.0% will likely have major market consequences.  Stay tuned.

As to the ECB, it seems highly unlikely that they will announce any policy changes this morning with the key issue being their discussion of the pace of QE purchases.  You may recall that at the April meeting, the key words were, “the Governing Council expects purchases under PEPP over the current quarter to continue to be conducted at a significantly higher pace than during the first months of the year.”  In other words, they stepped up the pace of QE to roughly €20 billion per week, from what had been less than €14 billion prior to that meeting.  While the data from Europe has improved since then, and reopening from pandemic induced restrictions is expanding, it would be shocking if they were to change their view this quickly.  Rather, expectations are for no policy change and no change in the rate of QE purchases for at least another quarter.  The inflationary impulse in the Eurozone remains far lower than in the US and even though they finally got headline CPI to touch 2.0% last month, there is no worry it will run away higher.  Remember, too, there is no way the ECB can countenance a stronger euro as it would both impair its export competitiveness as well as import deflation.  As long as the Fed continues to buy bonds at the current rate you can expect the ECB to do the same.

In the end, we can only wait and see what occurs.  Until then, a brief recap of markets shows that things have continued to trade in tight ranges as investors worldwide await this morning’s news.  Equity markets in Asia were very modestly higher (Nikkei +0.3%, Shanghai +0.5%, Hang Seng 0.0%) and in Europe the movement has been even less pronounced (DAX +0.1%, CAC -0.1%, FTSE 100 +0.3%).  US futures are mixed as well with the three major indices within 0.2% of closing levels.

Bond markets, after a strong rally yesterday, have seen a bit of profit taking with Treasury yields edging higher by 0.8bps while Europe (Bunds +1.0bps, OATs +1.6bps, Gilts +0.7bps) have moved up a touch more.  But this is trader position adjustments ahead of the news, not investors making wholesale portfolio changes.

Commodity markets are mixed with crude oil (+0.1%) barely higher while precious metals (Au -0.5%, Ag -0.4%) are under a bit of pressure.  Base metals, however, are seeing more selling pressure (Cu -1.5%, Al -0.2%, Sn -0.7%) while foodstuffs are mixed as wheat is lower though corn and soybeans have edged higher.

Finally, in the FX market, the G10 is generally mixed with very modest movement except for one currency, NOK (-0.5%) which has fallen sharply after CPI data came out much lower than expected thus relieving pressure on the Norgesbank to tighten policy anytime soon.  In the EMG bloc, ZAR (+0.6%) is the leading gainer after its C/A surplus was released at a much stronger than expected 5.0% indicating finances in the country are improving.  But away from that, things have been much less exciting as markets await today’s data and ECB statements.

In addition to the CPI data this morning, as it is Thursday, we will see Initial Claims (exp 370K) and Continuing Claims (3.65M).  Interestingly, those may be more important data points as the Fed is clearly far more focused on employment than on inflation.  But they will not be sensational, so will not get the press.  FWIW my money is on a higher than expected CPI print, 5.0% or more with nearly 4.0% ex food & energy.  However, even if I am correct, it is not clear how big a market impact it will have beyond a very short-term response.  In the end, if Treasury yields continue to fall, I believe the dollar will follow.

Good luck and stay safe
Adf

Kept at Bay

Posted on by

The key for investors today
Is payrolls and how they portray
The jobs situation
Thus, whether inflation
Will rocket, or be kept at bay

It’s Payrolls day, generally a session where there is a great deal of anticipation leading up to the release, often followed by a burst of activity and then a very slow afternoon.  However, given today also happens to be Good Friday, with all European markets closed in observation, as well as US equity markets, it is likely the burst activity, assuming one comes, will be compressed into an even shorter timeline than usual.  Of course, what makes this potentially unnerving is that market liquidity will be significantly impaired relative to most sessions, and any surprising outcome could result in a much larger move than would normally be the case.

It is not a bank holiday, which means the bond market will be trading, and that is, in truth, the market that continues to drive the action.  As evidenced by yesterday’s price action, the bond rally, with 10-year Treasury yields sliding 7 basis points, led to a declining dollar and new record highs in the stock market.  We also saw gold and other commodities rally as the combination of strong data (ISM at 64.7) and lower yields was a double-barreled benefit.

With that in mind, here are the latest expectations:

Nonfarm Payrolls 660K
Private Payrolls 643K
Manufacturing Payrolls 35K
Unemployment Rate 6.0%
Average Hourly Earnings 0.1% (4.5% Y/Y)
Average Weekly Hours 34.7
Participation Rate 61.5%

Source: Bloomberg

All that seems fine, but it is worth a look at the individual forecasts that make up that NFP number.  There is a wide dispersion of views ranging from a gain of just 350K to eight forecasts greater than 900K and three of those at a cool million each.

Let’s consider, for a moment, if the optimists are correct.  Harking back to Chairman Powell’s constant refrain regarding the recovery of the 10 million lost jobs, the expected timeline for that to happen remains sometime in late 2023.  But if this morning’s release is 1000K or more, that would seem to potentially shorten the timeline for those jobs to return.  And following that logic, it seems likely that the Fed may find themselves in a situation where ZIRP is no longer appropriate somewhat earlier in 2023 than currently expected as inflation rises, and unemployment falls back to their new goal of 3.5%-4.0%.  The implication here is that the bond market will anticipate this activity and we could see the 10-year yield break through to new highs quite quickly.  Based on broad market behavior as seen yesterday, a sharp decline in the bond market would likely result in the dollar rebounding sharply and equity futures, which are trading, retreating.  And all this on a day when there is much less liquidity than normal.

Of course, a weak number is likely to have just the opposite effect, with the bond bulls making the case that we have seen the high in yields, and dollar bears back in the saddle making the case the dollar’s run higher has ended.

And that’s really what we have in store for the day.  The two markets that were open overnight saw equities rally on the heels of the US equity rally, with the Nikkei (+1.6%) and Shanghai (+0.5%) both performing well.  Every European market is closed for the holiday and will be on Monday as well.  Meanwhile, US futures are all pointing modestly higher, roughly 0.25%, ahead of the payroll report.

As NY is walking in, we are seeing the first movement in Treasury yields and they have edged higher by 1.1bps at this point.  But as I highlight above, this is all about the data today.

In the commodity markets, only precious metals are trading but both gold and silver are essentially unchanged at this hour ahead of the data.  This follows yesterday’s strong performance with both rallying more than 1% in the session.

And finally, in the FX market, except for TRY (+0.7%) and KRW (+0.4%) there is no movement more than 0.2%, which is indicative of the fact that some positions are being adjusted but there is no news driving things.  In the case of TRY, the new central bank governor, in a speech today, made clear that he was not going to cut rates and that he was likely to raise them again in an effort to combat the rising inflation in the country.  This was well received by the market and has helped TRY recover much of its initial losses upon the sacking of the previous central bank chief.  As to KRW, they released CPI data last night, 1.5%, which was the highest print since January 2020, indicating that growth was persistent, and the BOK would be more vigilant going forward.  This also encouraged equity inflows resulting in the won’s modest appreciation.

So, now we wait for the payroll data.  Based on the releases that we have seen during the past couple of weeks, where the economy is clearly pushing ahead, I suspect this number will be somewhere above 800K, although 1000K is clearly not out of the question.  As such, my view is we will see the bonds sell off and the dollar retest its recent highs, if not break through them.

Good luck, good weekend and stay safe
Adf