Tag Archives: #gold

Limited Sellin’

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After the data on Friday
Powell said, rushing’s not my way
Rates, we’ll still lower
If growth turns out slower
Least that’s what the punditry might say
 
Forget any thoughts about hikes
Old ideas that nobody likes
Other than Yellen
Limited sellin’
Suggests there will be no yield spikes

 

“The fact that the US economy is growing at such a solid pace, the fact that the labor market is still very, very strong, gives us the chance to just be a little more confident about inflation coming down before we take the important step of cutting rates.”

When Chairman Powell expressed this sentiment Friday morning, my take was he was seeking to give himself an out.  One way to read it is, since the economy remains strong, higher for longer isn’t killing us.  However, my first reading of the statement was that since the economy is strong, they can confidently cut rates.  Perhaps it is my confusion, or perhaps it is simply a badly constructed statement of the first view, but regardless, my confidence in the process has not been enhanced.

Friday’s PCE data was released pretty much in line with expectations but that is not as helpful as you might think given expectations were for a continued rebound in the numbers.  The fact that Powell is not more vociferously calling for a tougher stance is the most important piece of the puzzle.  This is what tells me that he has abandoned the 2% target.  While he will never officially admit that is the case, it has become increasingly clear that to achieve that goal, the Fed will need to push much harder on the economy and possibly drive a recession.  My read is that there are very few FOMC members who are willing to accept that tradeoff, especially in a presidential election year.

Right now, as Q2 begins, there is still time to see inflation data ebb closer to their target and allow that June rate cut that he seems to be promising.  But if the data between now and then, which includes three NFP reports, three CPI reports and two more PCE reports, does not cooperate and continues to show economic strength and sticky, if not building, price pressures, Powell and friends are going to have a very hard case to make with regards to any rate cuts.  And this really cuts to the chase as it is increasingly clear that the Fed’s true goal is not to reduce inflation, but to reduce interest rates so government borrowing becomes cheaper.  If the Treasury is going to continue to flood the market with T-bills rather than coupons (see chart below from BofA Global Research), the Fed has the ability to reduce their interest costs directly.  I expect that the pressure to do so is immense and growing.  The Fed remains in a precarious position given their credibility is on the line and so much of it is dependent on things outside their control.

There continues to be a yawning gap between views on the economy in the analyst community.  One camp remains firmly committed to the soft or no-landing scenario, expecting ongoing economic growth as inflation magically fades away (the so-called immaculate disinflation).  The other camp sees a recession on the horizon, if not already arrived, as when breaking down the data, they are able to find key aspects which indicate growth is slowing rapidly.  Right now, my guess is Powell is praying for the recession to appear more clearly, so he has a good reason to cut rates because otherwise, any rate cuts are going to be much more difficult to explain.

Beyond the Fed story, the news overnight was about China and Japan as PMI data from the former showed unexpected strength (Caixin Manufacturing PMI to 51.1) while the latter saw a mixed picture with the PMI data rising to 48.2, but still below the key 50.0 level, while the Quarterly Tankan data had some good news for large manufacturers and not-so-good news for small manufacturers.  With all of Europe still closed for the Easter holiday, a look at the markets open in Asia shows that the Nikkei (-1.4%) found no joy in the data and the index slipped back below the 40K level.  However, Chinese shares rose (+1.6%) on the data as it seems any read of recent commentary from the nation’s leaders indicates more fiscal support is on its way.

Bond markets, too, are closed throughout Europe and so the overnight saw only JGB yields edge up 1bp, Chinese yields follow suit, rising 1bp while Treasury yields are higher by 3bps this morning.  My take is there is limited information in these movements given the overall lack of market activity.

In the commodity markets, oil prices are unchanged to start the day, although they rose more than 6% in March, so there is clearly upside pressure there.  But once again, the star is gold (+0.75%) which is at another new all-time high as it seems an increasing number of investors and traders are becoming more concerned over the ongoing flood of liquidity entering the markets.  This strength is gold is mirrored today in silver, copper and aluminum as the desire to own ‘stuff’ rather than paper continues to grow.

Finally, the dollar continues to be in demand versus essentially all its major counterparts.  With Europe out of the office today, movement has been muted, but it is firmer against every one of its G10 counterparts with NOK (-0.55%) and SEK (-0.5%) the laggards, while it remains stronger vs. most of its EMG counterparts, although ZAR (+0.3%) is benefitting from the strong rally in gold and precious metals.  When looking at the macro situation around the world, right now, the US remains the proverbial cleanest shirt in the dirty laundry and so has the lowest case to cut interest rates.  I believe the ECB and BOE (and BOC and Riksbank, etc.) will all be cutting before the Fed and the dollar will benefit accordingly.  However, as I have maintained for a long time, if the Fed starts cutting with inflation remaining well above target, the dollar will decline sharply.

Looking at the data this week shows we have much to anticipate, culminating in Friday’s NFP report:

TodayISM Manufacturing48.4
 ISM Prices Paid52.6
 Construction Spending0.6%
TuesdayJOLTS Job Openings8.79M
 Factory Orders1.0%
WednesdayADP Employment130K
 ISM Services52.6
ThursdayInitial Claims214K
 Continuing Claims1822K
 Trade Balance-$67.0B
FridayNonfarm Payrolls200K
 Private Payrolls160K
 Manufacturing Payrolls5K
 Unemployment Rate3.9%
 Average Hourly Earnings 0.3% ((4.1% Y/Y)
 Average Weekly Hours34.3
 Participation Rate62.5%
 Consumer Credit$16.5B

Source: tradingeconomics.com

In addition to the data, we hear from 15 different FOMC members across 18 speeches this week.  This includes Chairman Powell on Wednesday as he discusses the Economic Outlook at the Stanford Business, Government and Society Forum.  By the time he speaks, we will have seen the ISM and ADP data, but my guess is that nothing is going to change his mind right now.  At this stage, hotter data is the Fed’s real problem as it will make cutting rates that much more difficult.  The Atlanta Fed’s latest GDPNow reading ticked up to 2.3% for Q1, certainly not indicating a slowdown is coming.  Sit back and get your popcorn out, it is going to be interesting to watch the Fed explain why rate cuts are needed if the data continues along its recent trend.

Good luck

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One, Two, Three

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On Monday, no one could agree
So, Powell unleashed; one, two, three
At least with respect
To how they dissect
The prospect for rate cuts they see
 
For Bostic, he sees only one
Before the committee is done
While Cook thinks that two
Are likely to do
And Goolsbee said three need be spun

 

During a session with very little new news, and ultimately, very little in the way of net market movement, it was quite interesting to hear from three different Fed speakers with somewhat different views of what the future holds.

In order of their views, as opposed to the timing of their comments, Atlanta Fed President Raphael Bostic reiterated his view from Friday in a different venue.  He explained that given the resilience of the economy, he sees little reason for any rate cuts in the near term and that his ‘dot’ was for just one cut this year, later in the year.  The thing about Bostic is he has proven to be flexible, arguably adhering to the Keynesian concept of, when the facts change, he changes his mind.  While it is not clear to me that the facts have actually changed, his perception of them certainly has.  At this point, it appears that he has become one of the more hawkish FOMC members and he is a current voter on the FOMC.

One step further toward the median we found Governor Lisa Cook, who explained that “the path of disinflation, as expected, has been bumpy and uneven, but a careful approach to further policy adjustments can ensure that inflation will return sustainably to 2% while striving to maintain the strong labor market.”  In other words, we have been surprised by the two consecutive hotter than expected CPI reports and so despite our fervent desire to cut rates as quickly as possible, if we were to do so, whatever credibility we still have would be thrown away.  At least, that is how I read her comments as she is a clear dove and desperate to cut.  To her credit, as a governor, she is making the effort to be a bit more restrained.

Lastly, we heard from Chicago Fed President, Austan Goolsbee, who during his interview (at Yahoo! Finance) quickly highlighted that his ‘dot’ was for three cuts this year.  He further explained that housing was the problem, at least with respect to their forecasts, and why they had expected inflation to decline more rapidly. Now, based on the housing data we continue to see, at least the price data, inflation is unlikely to decline much further at all.  Add in the fact that commodity prices, notably energy prices, have been rebounding for the past month and any hopes for another leg lower in either CPI or PCE are slipping away.  Also, Goolsbee is not a current voter, so many take his views a bit less seriously.

Now, let me ask, do you feel more enlightened?  Me neither.  If I were to assess the current situation, my read is that the majority of the FOMC really does want to cut rates as they believe they have done enough regarding inflation.  Frighteningly, there was an article in the FT this morning from Mohamed El-Erian, claiming that the time is ripe for allowing inflation to run hotter in order to support nominal growth.  We know that is every FinMin’s wet dream, but historically central bankers pushed back on that thesis.  However, El-Arian now claims that the central banks are on board as well.  If this is true, the only conclusion is that all fiat currencies are going to decline in value vs. stuff.  The relative pace of these declines will ebb and flow based on interest rate differentials and other circumstances, but it is not a net positive for the ordinary consumer.

Ok, let’s turn our attention to the overnight session and how markets are behaving.  The bulls have to be disappointed that the recent Fed speakers have not been more dovish, and we have seen that in another lackluster equity session in the US yesterday, with all three major indices lower by about -0.3%.  In Asia, while Japanese shares were essentially unchanged, we saw some strength in China and Hong Kong with the noteworthy story being President Xi’s invitation to keep several US CEOs currently visiting there, in country with the promise of a meeting with him.  The read is he is open to deeper business relationships.  As to the rest of the region, equity markets were mixed with some gainers and some laggards and no large movers.  As to Europe this morning, the color on the screen is green, with a few gains of 0.5% (Germany and Spain) and the rest much more subdued.  US futures are pointing higher at this hour (7:00), by about 0.5%, so the bulls are back.

In the bond market, yields have backed off a bit with Treasuries lower by 2bps and European sovereigns falling between 3bps (Germany) and 6bps (Italy) as the ECB speak continues to point to rate cuts clearly coming, with more hope for April making its way into the market, at least according to Italy’s Panetta.  In what cannot be a huge surprise, 10-year JGB yields remain unchanged as the idea of a tightening cycle there is slowly ebbing from traders’ minds.

In the commodity markets, oil (+0.2%) is creeping higher again as Russia has indicated it is going to restrict production alongside the lost output from refinery damage caused by Ukraine.  As well, after the UN Security Council vote yesterday, it appears that concerns are rising that there is no chance of a ceasefire anytime soon.  Meanwhile, gold (+1.2%) is screaming higher this morning and once again approaching $2200 as what appears to be a combination of growing geopolitical jitters combines with the growing awareness by market participants that inflation is not going to be addressed has investors seeking alternatives to fiat currencies.  Base metals, though, are not seeing the same boost, although are a touch higher overall.

Finally, the dollar is under some pressure this morning with most G10 currencies firmer, although the Swiss franc (-0.2%) is suffering a bit.  In fact, the biggest winner is NZD (+0.45%) but there is precious little to explain this movement.  One currency that is not gaining is the yen, which is unchanged on the session while the dollar remains just below its multi-decade highs set back in October 2022.  In the EMG bloc, the story is more mixed with some gainers (CZK +0.2%, HUF +0.3%) and some laggards (ZAR -0.3%, TWD -0.2%), but as you can see, the movement has been muted.

On the data front, this morning brings Durable Goods (exp 1.1%, 0.4% ex-transport) and Case Shiller Home Prices (6.7%). We also see Consumer Confidence (107.0) at 10:00.  There are no Fed speakers scheduled, but do not be surprised if there is an interview or two from a news source as they continue to try to tweak their message.

To me, the big picture is that there has been a clear relaxation by the Fed, and other central banks, in their attitude toward inflation.  As such, I expect to see risk assets perform and bonds lag.  However, regarding FX, it is all about the timing of the changes that are announced, or guided, rather than the absolute destruction in their value over time.  For now, though, the Fed remains the tightest policy around and the dollar should benefit because of that.

Good luck

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Cooed Like Doves

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Well, Jay and the Fed cooed like doves
And treated the bulls with kid gloves
But under the hood
Was it quite so good?
It’s clear number up’s what he loves!
 
The upshot is stocks really soared
As everyone’s sure Jay’s on board
To cut first in June
And thrice when Cold Moon
Is seen, near the birth of our Lord

 

Whatever the pundits thought about the hottish inflation readings in January and February, they clearly did not read the room properly, at least not the room in the Eccles Building.  Despite raising their 2024 forecasts for GDP growth (2.1% from 1.4%) and Core PCE (2.6% from 2.4%), as well as maintaining their forecast for the Unemployment Rate to remain quiescent (4.0% to 4.1%), they are hell-bent on cutting rates this year, with June still the most likely starting point.  I created a little table to show, however, that perhaps the consensus is not quite what the headlines would have you believe.

 DecMar
 MedianAvgMedianAvg
20244.6254.7044.6254.809
20253.6253.6123.8753.783
20262.8752.9473.1253.066
Longer Term2.5002.5862.6252.813

Source: Data FRB, calculations @fx_poet

The highlighted points show that while the median for 2024 remained the same, the average was nearly a full cut less.  In fact, if one more member had adjusted their forecast higher, the median would have come out for just 2 cuts this year.  But as I wrote yesterday, perhaps of more importance is the Longer Term view, where not only did the median rise by 12.5bps, but the average is substantially higher, a full 25bps higher than the December views.  

However, the market has ignored this wonkish number crunching and accepted the numbers at face value; three cuts this year and three more next year helping drive equity prices to yet another set of new all-time highs.

Regarding the tapering of the balance sheet, Powell explained at the press conference that they had, indeed, discussed the topic as they were trying to determine the best way to continue the process without any untoward events, but that is not the issue.  The issue is…BUY STONKS!!!

I would estimate that Chairman Powell is pretty happy with the outcome and am certain that Secretary Yellen is very happy with the outcome.  After all, the equity rally continued while bond yields managed to drift lower by a couple of basis points.  But the really happy campers are the holders of gold which rallied more than 1% and traded above $2200/oz for the first time ever.  The market has reviewed this outcome and decided that the biggest risk going forward is a further devaluation of the dollar vs. stuff, although vs. other fiat currencies it is likely to hold its own.  In other words, inflation ain’t dead.  I expect the bond market to determine this is the case over the next several weeks and see yields rising further, especially if the PCE data next week is hot again.

While Jay may have had the most press
In Switzerland, Tom did aggress
He cut twenty-five
In order to drive
Their growth with a bit more largesse

 

This morning, we have seen three more G10 central banks and the only surprise comes from Switzerland, where soon-to-retire President, Thomas Jordan, cut their base rate by 25bps to 1.50%.  While there were several analysts who had suggested this might be the case (including this poet on Monday), the bulk of the market was in the no change camp.  However, cut they did, and the result was an immediate 1.1% decline in the Swiss franc, arguably a key part of their goal.  In the statement, they explained that inflation had been well within their target range, and they would have the tool of further currency intervention if they felt the franc was weakening too much.

One theory on the surprise cut is that the SNB wanted to get ahead of the pack as they only meet 4 times each year and their next meeting is after the June Fed and ECB meetings.  As well, many pundits are now saying this is the “proof” that the Fed and ECB are going to cut in June.  My take is that while I agree the ECB is a done deal come June, I think the Fed may have a tougher time as there is still no evidence that inflation is heading back to their 2% target.  We have two more CPI and PCE reports before the June meeting, and if the recent price activity continues (and given energy prices remain buoyant I expect they will), it will be very difficult for Chair Powell to explain the need to cut rates unless Unemployment is surging.  Perhaps that will be the case, but right now, the data does not indicate things are collapsing.  The next three months should be quite interesting.

Ok, let’s see how other markets have responded to Powell and the SNB surprise.  Equity markets are in a happy place right now after records fell in the US yesterday.  The Nikkei (+2.0%) also set a new record and the Hang Seng (+1.9%) continued its recent rebound.  In fact, only mainland Chinese stocks couldn’t muster a rally last night, with every other nation in APAC in the green, often by more than 1%.  In Europe, though, the picture is a bit more mixed with more gainers than losers, but still several nations seeing modest pressure on their equity indices.  It should be no surprise that Swiss stock markets are higher, but France and Denmark are suffering somewhat today.  The best performer is the UK (+0.9%) which seems to be benefitting from a solid uptick in its Flash Manufacturing PMI (49.9, exp 47.8).  Lastly, in what should not be a surprise at all, US futures are pointing higher across the board.

In the bond market, all is right with the world this morning as there are bids everywhere with yields declining correspondingly.  Treasury yields slipped another 4bps overnight and throughout Europe, we are seeing declines between 3bps and 5bps with Swiss bonds lower by 7bps.  In fact, Asia is where things were modestly different as JGB’s remain unchanged (tighter policy remains an idea not a reality yet) and Australian yields rose after much stronger than expected employment data was released last night.

In the commodity space, oil (-0.25%) is a touch softer after a decline of more than 1% during yesterday’s session.  With all the focus on the Fed, there was not a lot of news driving things here specifically.  But the real winner in the commodity space is gold (+1.0%) as the market appears to be calling BS on the Fed’s inflation and QT forecasts.  The thing to remember about gold is it is not so much a good hedge for consumer inflation, but it is a very good hedge for monetary inflation (i.e. the excess printing of money).  While those two inflations tend to be correlated, they are not tick for tick, so gold seems to be amiss at times.  But the very idea that despite ongoing inflationary pressures, and the continued supplying of liquidity by the global central banking cast, is the right time to cut interest rates is a step too far for gold markets.  I believe this has room to run higher.  As well, copper (+0.7%) is also rebounding, and I expect that we will see most commodities continue to perform well going forward in this environment.

Finally, the dollar is under some pressure this morning, adding to yesterday’s declines in the wake of the Fed meeting.  Recall, the dollar had rallied the first half of the week as the punditry was looking for the Fed to seem more hawkish.  But that was not to be and this morning it is broadly, though not universally lower.  AUD (+0.3%) and JPY (+0.2%) are the biggest gainers in the G10 while CHF (-0.65%) is the laggard after the rate cut, although has rebounded from its worst levels.  In the EMG space, PHP (+0.4%), MYR (+0.5%) and IDR (+0.4%) are the leading gainers although we are seeing weakness in EEMEA with ZAR (-0.3%) and CZK (-0.3%) lagging.  

On the data front, as it is Thursday, we see Initial (exp 215K) and Continuing (1815K) Claims as well as the Current Account deficit (-$209B) and Philly Fed (-2.3) all at 8:30.  Then as the morning progresses, we see the Flash PMI data (51.7 Manufacturing, 52.0 Services), Existing Home Sales (3.94M) and Leading Indicators (-0.2%).  As well, we get our first Fed speaker post the meeting, vice-chairman for regulation Michael Barr, this afternoon, but given my assessment that the Fed is happy with the market response, I don’t imagine he will say anything new.

Overall, the bulls and doves are walking hand in hand (what a terrible metaphor, sorry) and that means that risk assets are likely to continue to perform well for now and the dollar seems likely to come under a bit more pressure.  I maintain that the bond market is going to figure out the inflation story is not great and react, but that is not today’s story.

Good luck

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Not Very Far

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Said Jay, we are not very far
From when we can all wave au revoir
To higher for longer
With confidence, stronger,
Inflation will reach our lodestar
 
“We’re waiting to become more confident that inflation is moving sustainably at 2%.  When we do get that confidence — and we’re not far from it — it’ll be appropriate to begin to dial back the level of restriction.”  So said Chairman Powell yesterday in front of the Senate Banking Committee in response to some of the questions he received.  Nuff said!  Regardless of the fact that there has been limited indication of slowing economic activity (although this morning’s payroll report will be critical), it seems quite clear that Powell is under a great deal of pressure to reduce rates.  One must assume this pressure comes from the White House as in last night’s SOTU speech, President Biden even mentioned that mortgage rates were too high, and he was going to push them down.  Clearly, the only tool that Biden has is to lean on Powell to cut rates.
 
But despite what had appeared to be a concerted effort by every Fed speaker to push back against the proximity of the first interest rate cut for this cycle, it appears that Powell is blinking.  Interestingly, while the Fed funds futures markets didn’t really adjust very much, we did see the 2yr Treasury yield fall back 5bps and this morning it sits slightly below 4.50%, its first time back to this level since the surprising CPI print last month.  Of course, equity markets love the message, and we continue to see new highs on a daily basis.  But we are also continuing to see new highs in the anti-fiat monies, gold and bitcoin.  The world is not without risk.
 
An angry old fella named Joe
Last night tried explaining our woe
Was not his, to blame
Though he wouldn’t name
The culprit, throughout the whole show
 
While I try to leave politics out of this missive, the status of the SOTU is such that I don’t believe it can be completely ignored.  My takeaway from last night’s speech was that President Biden, in an attempt to show vigor, came across as the angry old man shaking his fist and yelling at the clouds.  He had a laundry list of things he claims to want to accomplish, all of which will cost trillions of dollars, and none of which are likely to be enacted before the election.  Many pundits pointed out this seemed more like a campaign speech than a SOTU and I think there is merit in that view.  In the end, while we understand where the pressure on Powell is coming from, I don’t believe this is going to change anything, certainly not from a market perspective.
 
And finally, it’s time to turn
To data for which we all yearn
The Payroll report
Which, if it falls short
Will likely give hawks great heartburn

Looking ahead, this morning brings the monthly payroll report.  Current median expectations are as follows:

Nonfarm Payrolls200K
Private Payrolls160K
Manufacturing Payrolls10K
Unemployment Rate3.7%
Average Hourly Earnings0.3% (4.4% Y/Y)
Average Weekly Hours34.3
Participation Rate62.6%

Source: tradingeconomics.com

Recall, last month’s number was massively higher than anticipated at 353K and had higher revisions as well.  The revisions were almost more surprising than the headline number as the trend for the entire previous year had been for revisions to be to softer data.  There will certainly be revisions to the January data as well, so there is a great deal of uncertainty.  My sense is, though, that the market really wants to see a softer number with downward revisions as that will work toward cementing the case for the Fed to cut rates even sooner.  Sub 150K and look for a bond and stock rally.  Above 250K and bonds will sell off, although stocks have a life of their own.  At least that’s one man’s view.

Ok, let’s look at how things played out overnight ahead of this key data.  Asian markets followed the US rally with green across the screen.  The Hang Seng, which is seen as the tech proxy in Asia, rallied most, 0.75%. Europe, on the other hand, is having a tougher day with most markets slightly softer although the FTSE 100 is down -0.5%, the clear laggard this morning.   Apparently, Madame Lagarde’s comments did nothing to support the hopes that rate cuts were coming soon as ostensibly, rate cuts were not even discussed in the meeting and all signs point to June as the first time by which they will have confidence in the inflation story, if it is to come.  Meanwhile, US futures are pointing a bit lower, -0.3%, at this hour (8:00).

In the bond markets, Treasuries have edged lower another 1bp this morning and we are seeing yields across the board in Europe decline by between 2bps and 4bps.  I can’t tell if that is confidence in the ECB (doubtful) or belief that the ongoing decline in economic activity (Eurozone GDP in Q4 was confirmed at 0.0% Q/Q and 0.1% Y/Y) has simply encouraged investors that rates are going to fall with no chance of a backup.  Meanwhile, JGB yields were unchanged overnight despite the ongoing excitement(?) that the BOJ may raise rates a week from Monday.

Oil prices have retreated a bit (-0.6%) but are essentially range trading and have been for the past month.  However, the star of the commodity space continues to be the barbarous relic, with gold rallying another 0.3% this morning to yet another new all-time high.  As to the base metals, copper is unchanged this morning, but has been on a roll lately while aluminum is higher by 0.65%.  Metals investors are gaining confidence that not only is there going to be no landing in the US, but that China is going to stimulate more.

Finally, the dollar remains under pressure overall as yields continue to decline.  While the euro is a touch softer this morning, virtually every other G10 currency is firmer with JPY (+0.55%) leading the way.  Remember, too, that with FY end approaching for Japan, we will begin to see Japanese corporates repatriating funds which typically sees further yen strength.  Combine that seasonal activity with the relatively new BOJ hawkishness/Fed dovishness combination and the yen could rally a lot more.  After all, it has fallen a lot in the past two years!  But, while the G10 currencies are generally having a good day, the picture in the EMG bloc is far more mixed with BRL (-0.6%) the laggard after total credit in Brazil was shown to have fallen in January for the first time since the pandemic.  On the flipside, CLP (+1.0%) is rallying after a higher-than-expected CPI report (4.5%) has traders looking for tighter monetary policy than previously anticipated.

Aside from the payroll report, there is no other data to be released and there are no Fed speakers on the calendar.  Yesterday we did hear Cleveland Fed president Mester sound more hawkish, becoming the third FOMC member to discuss only 2 cuts this year, and I maintain that when the dot plot comes out, that could be the median view.  But for now, markets and investors remain euphoric about the apparent Powell dovishness, so that will be the driver absent a huge NFP this morning.  For the dollar, that will be bad news.

Good luck and good weekend

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Now Estranged

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“Something appears to be giving”
Said Waller, the true cost of living
So, bonds rallied hard
The dollar was scarred
But stocks were quite unreactive-ing

The narrative clearly has changed
With hawks on the Fed now estranged
Is everything better?
As world’s largest debtor
We need low rates to be arranged

Fed Governor Chris Waller, one of the erstwhile hawks on the FOMC was covered in white feathers yesterday as he explained his latest perception that the Fed was on a path to achieving their 2% inflation goal as Q3’s expansive GDP was clearly an outlier and the data he cited showed economic growth slowing toward trend just below 2%.  The other Fed speakers on the day did not back him up specifically, and in fact, Governor Bowman explained her base case was the Fed needed to hike still further to be certain inflation was under control.  However, the market only had eyes for Waller and has heard the following message from the Fed, ‘we have finished hiking, and the next move will be a cut.’  Although this had been a building narrative, until yesterday there had been consistent pushback from virtually every Fed speaker with the higher for longer mantra.  However, the current belief set is that higher for longer has just been buried and that lower rates are in our future.  Let the celebrations begin because the Fed has achieved the much discussed, though rarely achieved, soft-landing.

However…it is still a bit premature, to my mind, to celebrate accordingly.  In fact, just yesterday the Case Shiller Home Price Index showed an annual rise of 3.9%, which although 0.1% less than forecast, also shows that the widely claimed decline in house prices due to higher yields, has not materialized.  And consider, if yields are set to go lower, the idea that house prices are going to fall and feed into lower inflation seems absurd unlikely.

But logic has never been an important part of any market narrative, and this time is no different.  The fact that declining bond yields (Treasuries fell 6bps yesterday and a further 5bps in the aftermarket) and the fact that the dollar, as measured by the DX, fell 0.5% led by USDJPY falling nearly 1.5% to its lowest level since September, has eased financial conditions thus supporting economic activity and inflation, is of no importance to the narrative.  Once again, we have heard from some big-name traders, Bill Ackman in this case, claiming that the Fed is now going to cut well before the market is pricing, predicting the first cut in March 2024. The market response to this has been for Fed funds futures to price a 40% chance of a March cut and a 75% chance of one at the May meeting.

And maybe all this is correct.  However, as I wrote yesterday, I believe that we are going to see a significant additional amount of federal government largesse to help prop up the economy, and that is not going to push inflationary pressures lower, the opposite in fact.  As is always the case, nothing matters until it matters, and right now, the only thing that matters is that the narrative is all-in on rate cuts coming soon to a screen near you.  While we could easily see further short-term weakness in equity markets as portfolios rebalance after a huge equity rally this month, it certainly seems like a push higher in risk assets is on the cards into Christmas.

As we consider the price action from yesterday and overnight, the thing that really stands out is that the US equity markets did so little on this very clear change in tone from a key Fed speaker.  Had you told me this was going to be Waller’s attitude prior to the session, I would have expected US equity markets to rally by 1+% each, with the NASDAQ really embracing the idea of lower rates.  But while the three major indices all closed in the green, it was only at the margin, +0.1% – +0.3% with a very late day rally.  Yes, futures are pointing higher this morning, up about 0.3% across the board, but again, this is somewhat unimpressive.  Perhaps the market has already priced in this idea, hence the 10% rally in November.

There is another wrinkle in this narrative as well, and that is that APAC shares are underperforming in both China and Japan.  Regarding the former, the Hang Seng (-2.0%) fell again as continuing concerns over Chinese corporate growth and profitability weigh on the index with Meituan reporting poor results.  On the mainland, despite hopes that the government was going to do more to support the property market, thus far it has been all talk, and no action and investors are getting tired of waiting.  Europe, however, is having a better go of it this morning, excluding the UK, where continental indices are all nicely higher, at least 0.5% with some as much as 0.9%.  

Not surprisingly, European debt markets are rallying as European sovereigns are following the US lead, ignoring the pleas from ECB speakers that higher for longer remains the path forward.  As such, we are seeing further declines on the order of 4bps – 6bps across the continent, matching US yield declines for the past two days.  Yields in Asia, though, are quite interesting with some very different narratives playing out there.  Starting with Japan, which saw yields fall 9bps last night, back to their lowest level since September, we heard from BOJ member Seiji Adachi that it was premature to consider exiting ultra-loose monetary policy amid global economic uncertainties and the end of the aggressive rate hikes in the US.  That seems counter to what had been the building narrative regarding Ueda-san’s next move.  Australia saw yields decline 14bps but in New Zealand, the decline was much more muted, just 2bps, after the RBNZ left rates on hold, as expected, but was far more hawkish in their statement than expected and hinted at potential further rate hikes.  

Turning to the commodity markets, oil continues to rebound, rallying another 1.8% this morning and recouping all its recent losses as confusion still reigns over the OPEC+ meeting tomorrow, or perhaps to be delayed again.  As well, it seems that a massive early winter storm closed ports in the Baltic and so oil shipments have been interrupted there for the time being.  Gold, though, has been the big story in commodity markets as it exploded higher yesterday after the Waller comments, jumping $30/0z (1.5%) to levels last seen in May and once again approaching its all-time highs of $2085/oz.  The market technicians are getting quite excited as they see a break there as having potential for a much larger run higher.  A case can be made that this is not a vote of confidence in the Fed’s anticipated future handling of inflation, but for now, we can simply attribute it to lower interest rates around the world.

Finally, the dollar has taken a straight-right to the chin and is reeling against virtually all its counterparts, both G10 and EMG. While we have seen a bit of a rebound this morning, since Monday’s close, EUR (+0.3%), GBP (+0.5%) and JPY (0.65%) have all rallied nicely, and that is after giving up some of those gains overnight.  We saw similar movement in the EMG bloc with CNY (+0.3%), PLN (+0.3%) and BRL (+0.8%) all responding positively to the Waller comments.  As I have been saying recently, if the Fed is truly done, then the dollar is likely to suffer, at least until such time as the other central banks fall in line.

On the data front, in addition to the Case Shiller Home Prices yesterday, we saw Richmond Fed Manufacturing which disappointed at -5.0 (exp 1.0), yet another sign that growth is waning.  It is data like this that has Waller in the mindset that slowing growth will lead to lower inflation.  Of course, rising home prices would certainly be a crimp in that theory.  Today we see the second look at Q3 GDP (exp 5.0%) with Real Consumer Spending expected at +4.0%.  We also get the Fed’s Beige Bok at 2:00pm and Cleveland Fed president Mester speaks at that time.  It will be interesting to hear if Mester, a very clear hawk, confirms the Waller thoughts or tries to push back alongside Governor Bowman.

For now, while the dollar has bounced slightly this morning, as long as the narrative remains the Fed is done and that cuts are coming soon, you have to believe the dollar is going to fall further from here.  If pressed, I would suggest USDJPY has the furthest to decline, but the fact that we have already had pushback from the BOJ implies that they are not that unhappy it remains weak.  After all, it supports their corporate sector and helps keep inflation higher, which remains one of their goals.

Good luck

Adf

Dim-Witted

Posted on by 
Said Jay, though we’re strongly committed
To make sure no ‘flation’s permitted
Quite frankly we’re lost
And ‘fraid of the cost
If we screw up cause we’re dim-witted

So, we’ll watch the data releases
And act if inflation increases
But if it should fall
Then it will forestall
More hiking lest we step in feces

As expected, the Powell comments were yesterday’s highlights as he once again explained that the goal of 2% inflation remains their primary effort.  Not surprisingly, given what we have heard from the onslaught of Fed speakers over the past two weeks, he made clear that there will be no rate hike at the November meeting, but December is still in play.  When asked about the rise in long-term yields, he did indicate it could be doing some of the Fed’s work for them, just like we heard earlier this week from Lorrie Logan and others.  Somewhat surprisingly, he mentioned the rising budget deficits, describing them as on an “unsustainable” path.  Now, we all know this is true, but Powell has been extremely careful not to discuss government funding throughout his tenure as Chair.  I suspect his next testimony to Congress could be a little spicier!

Of course, the other six speakers added exactly nothing to the conversation as they merely reiterated in their own words the same message.  Perhaps of more interest was that despite effective confirmation that there was no hike upcoming and that the bar for a December rate hike was quite high, bonds continued to sell off with the 10yr yield closing at 5.0% while stocks took it on the chin again.  Methinks there is more than a little concern starting to grow amongst asset managers that the concept of the Fed put may finally be gone.  

The other really interesting outcome yesterday was the fact that gold rallied another 1.3% despite the ongoing rise in interest rates.  As there was no new news out of the Middle East of any real note, one possible explanation is that investors are simply getting quite scared overall.  

One thing is quite certain and that is if the situation changes such that Powell and company become concerned that the economy is reversing course and they have, in fact, overtightened monetary policy, any reversal of the current message is likely to lead to some very big moves.  In that case I would expect a much weaker dollar, a huge rally in gold and other commodities, an initial rally in equities and, remarkably, not much movement in bonds.  I remain of the strong belief that the supply issue is the key bond market driver, so that will only increase in the event of an economic slowdown and that cannot help the bond market, even if the Fed starts to buy them again.  But that is all hypothetical.

Turning to the overnight session, while risk continues to be shed in Asia and Europe, we did see Japanese inflation data where the headline rate declined to 3.0% and the core to 2.8% although their super core reading is still at 4.2%.  Certainly, Ueda-san must be pleased that the numbers are beginning to edge a bit lower although they remain far above the 2% target.  Of course, the very fact that they are edging lower implies that any end to QQE is even further in the future.  Recall, Ueda-san has been clear that he does not believe 2% inflation is yet sustainable in the economy and is concerned it is going to slip back below that level in the medium term.  With that attitude, he has exactly zero incentive to end YCC or QQE and seems far more likely to continue with them.  

The implication of this outcome is that the yen seems likely to weaken further.  Currently, USDJPY is trading at 149.95 and although it hasn’t touched the 150 level since that first brush on October 3rd, it has been grinding ever so slowly back there again.  This price action has all the earmarks of stealth intervention, something that may be carried out by the three Japanese mega banks at the BOJ’s behest.  However, given the ongoing trajectory in US interest rates, it seems only a matter of time before we once again breech 150.  It will be quite interesting to see the MOF/BOJ reaction at that time, although I suspect they will, at the very least, “check rates.”  For hedgers, be careful here.

And really, that’s all we’ve got to talk about today.  As mentioned above, equity markets fell in Asia overnight, with losses on the order of -0.5% or so and European bourses are all down about -1.0% this morning heading into the US open.  As to US futures, at this hour (7:00) they are off about -0.4% as we head into an option expiration session.  Thus far, earnings season has not been sufficient to excite investors and fear seems to be the driver of note.

Turning to the bond market, while we have backed off from yesterday’s closing highs of 5.0% by 5bps, we remain at multi-year highs and there is no reason to believe that we have seen the top in yields.  In fact, this move appears to be driven by rising real yields, not inflation concerns.  While real yields have already risen substantially over the past 6 months, rising from ~1.0% to the current 2.45%, history has shown that real yields can easily rise to 4% or more in the right circumstances, and these may just be those circumstance.  Again, there is no evidence that Treasury yields have topped.  As to European sovereigns this morning, they are edging lower by about -1bp after a large rally yesterday as well.  US Treasury price action continues to be the global driver for now.

Oil prices (+1.5%) continue to trade higher as concerns over a widening of the Israeli-Palestinian conflict keep traders on edge.  Combine this with the weaker production numbers from the US and the drawdown in inventories and you have the ingredients for a further price rally.  News that a US Missile Cruiser in the Red Sea shot down several drones and missiles launched from Yemen cannot have helped sentiment.  Meanwhile, gold (+0.4%, +2.6% this week) continues to play the role of safe haven.  Either that or there is a lot of short-covering ongoing.  The price is approaching $2000/oz, one of those big round numbers on which markets tend to focus so I would look for a test there if nothing else.  However, base metals are softer this morning as the price action today is not economically related.

Finally, the dollar continues to tread water this morning with most of the major currencies within +/- 0.2% of yesterday’s closing levels while EMG currencies seem to be edging a bit lower, down on the order of -0.3%.  The renminbi is little changed this morning despite (because of?) the PBOC injecting CNY733 billions of fresh liquidity into the market/economy there overnight.  Again, just like the yen, the diametrically opposed monetary policy of China and the US should lead to further currency weakness here over time.  Now, the PBOC doesn’t like to see sharp movement and will continue to prevent a blowout move, but the spot rate is currently trading right at its 2% band vs. the CFETS fixing, so something has got to give soon.  In the end, the dollar trend remains intact, but I must admit I am surprised it is not a bit stronger given the underlying fear in the market.

On the data front, there are no statistics released and we hear from two more Fed speakers, Harker and Mester, to finish things off before the quiet period begins.  It seems hard to believe that anything they say will be seen as more important than Powell’s comments yesterday.  As such, looking at today’s market activity, while there will be tape-watching regarding the Middle East and any escalation in hostilities, I suspect the equity market will have the most influence on things.  At this point, further weakness seems the most likely outcome, especially as traders will be reluctant to be overly long risk heading into the weekend.  

Good luck and good weekend

Adf

Growth Dynamo

Posted on by 
The data continues to show
Economies still want to grow
Here in the US
The Retail success
Came ere China's growth dynamo

The upshot is all of the talk
That bonds are where people should flock
Turns out to be wrong
Then those who went long
Are likely to soon be in shock

Wow!  That’s all you can say about the data from yesterday where Retail Sales were hot and beat on every measure (headline 0.7%, ex-autos 0.6%, control group 0.6%) while IP (0.3%) and Capacity Utilization (79.7%) also indicated that economic activity remains quite robust in the US.  On the data front, this was followed by last night’s Chinese data dump where every one of their monthly indicators; GDP (4.9%), IP (4.5%), Retail Sales (5.5%), Fixed Asset Investment (3.1%), Capacity Utilization (75.6%) and Unemployment (5.0%), was better than expected.

Perhaps the idea that a recession is right around the corner needs to be reconsidered.  And remember, I have been in that camp as well, but the data is the data and needs to inform our opinions.  The immediate reaction to yesterday’s US data was a sharp decline in both stocks and bonds, while oil rallied, gold edged higher and the dollar tread water.  Of this movement, I was most surprised at the dollar’s lack of dynamism given the rate situation.  Unremarkably, given the ongoing belief in the Fed pivot, by the end of the day, US equities were tantamount to unchanged.  But the bond market remains under severe pressure with yields having risen another 12bps in the 10-year and having now reversed the entire safe haven move on the back of the Israeli-Hamas war situation.  

I continue to believe that yields have much further to rise and stronger data will only add to the case.  My view had been based on the combination of stickier inflation than the punditry describes along with massive amounts of new issuance requiring a lower price (higher yield) to clear markets.  But if we are going to continue to see strong economic growth, then there is an added catalyst for yields to rise.

One of the problems about which we hear constantly these days is the fact that there are no more natural buyers of US Treasury debt, at least not at current yield levels.  Many point to the decline in ownership by both Japan and China, the two largest foreign holders of Treasuries, and claim they are both selling their holdings.  However, I have a quibble with that thesis and would contend that perhaps, they are merely suffering the same mark-to-market losses that the banks are.  For instance, according to the US Treasury Department, holdings by these two nations from July 2022 through July 2023 declined by -9.6% (Japan) and -12.5% (China) respectively as can be seen in the chart below.  (data source US Treasury)

But ask yourself what has happened to interest rates over the past year?  They have risen dramatically (10yr yields +85bps) and that means the price of bonds has declined.  As a proxy, in the past 12 months, TLT (the long bond ETF) has declined by more than 13% in price.  So, if you have the exact same amount of bonds and their prices declined by 13%, it is not hard to understand how when you measure the value of your portfolio it has shrunk by upwards of 13%.  I have no idea what the maturity ladders for Japan and China look like, and it is likely they own a mix of short and long-dated bonds, but it is not at all clear to me they have actually been selling Treasuries.  Likely, they are simply holding tight, and I would not be surprised, given the dramatic rise in yields here, if they roll maturities into new bonds.  All I’m saying here is that the narrative about everybody fleeing bonds may not be correct.  In fact, regarding the TLT, which is a pretty good proxy for bond demand of the retail investor, there is a case to be made that demand is quite high.  My understanding is that calls on the TLT are amongst the most active contracts in the options market, and people don’t buy calls if they are bearish!

With that in mind, though, the underlying point is US yields continue to rise and that is going to be the driver for all markets.  In global bond markets, the US unambiguously leads the way and we have seen European sovereigns show similar movement to the US with large moves higher in yields yesterday, on the order of 10bps – 15bps depending on the nation, and consolidation today with virtually no movement, the same as Treasuries.  Last night, JGB yields managed to rally 3bps as well, another indication that as goes the US, so goes the world.

But the more interesting thing to me is the ability of the equity market to hold onto its gains.  The fact that US markets rallied back nearly one full percent from the immediate post-data lows was quite impressive.  Consider that the leadership of the US stock market has been the so-called magnificent 7 tech stocks (Apple, Microsoft, Google, Amazon, Nvidia, Meta (nee Facebook), and Tesla) most of which are essentially long duration assets with their extreme values based on a belief that they will continue to grow at incredible rates.  But with yields rising, the present value of those anticipated earnings continues to decline which should generally be a negative for their price.  So far, they have held up reasonably well, but cracks are definitely starting to show.  I suspect that at some point in the not-too-distant future if yields continue on their current trajectory, that equity market comeuppance will arrive and these stocks will feel the brunt of it.  But not yet apparently.  Interestingly, despite the positive Chinese data, equities in Hong Kong and the mainland both declined about -0.5%.  And looking at Europe, weakness is the theme with all the major bourses lower by -0.5%.  As to US futures, -0.25% covers the situation at this hour (8:00).

Meanwhile, the escalation in Israel and concerns about a wider Mideast war have joined with the stronger economic data, especially from China, to push oil prices higher again this morning, up 1.8%.  And that war theme has gold rocking as well, up 1.3% to new highs for the move with both copper and aluminum rising on the better economic data.  High nominal growth and high inflation (so low real growth) is going to be a powerful support for commodity prices.

Finally, turning to the dollar, this is where I lose my train of thought.  Given the higher yields and seeming increased worries about a wider Mideast war, I would have expected the dollar to continue to rally.  But that has not been the case.  Instead, it has been stable, stuck in a tight range against most of its major and emerging market counterparts.  Perhaps this market is waiting to hear from Chairman Powell tomorrow before traders take a view, but I need to keep looking for a reason to sell the dollar as the evidence to buy it seems strong, higher yields and safety.

Today’s data brings Housing Starts (exp 1.38M) and Building Permits (1.45M) as well as the EIA oil inventory data.  We also hear from a bunch more Fed speakers; Waller, Williams, Bowman Harker and Cook, so it will be interesting to see if there are more definitive views on a pause, especially after the recent hot data.  I have not changed my view that the dollar has further to rise, but its recent relative weakness is a potential warning that something else is driving things.  I will continue to investigate, but for now, higher still seems the better bet.

Good luck

Adf

Quite Insane

Posted on by

There once was a concept, inflation
That frightened the heads of each nation
As prices would rise
They could not disguise
The fact it was just like taxation

But now, though it seems quite insane
Most governments try to explain
No need for dismay
Inflation’s okay
There’s no reason you should complain

The latest example is from
The UK, where people’s income
Continues to lag
Each higher price tag
And prospects for growth are humdrum

It certainly is becoming more difficult to accept the idea that the current inflationary surge being felt around the world is going to end anytime soon.  I keep trying to imagine why any company would cut prices in the current macroeconomic environment given the amount of available funds to spend held by consumers everywhere.  So called ‘excess’ savings, the amount of savings that are available to consumers above their long-term trend, exceed $3 trillion worldwide, with more than $2 trillion of that in the US alone.  If you run a company and are being faced with higher input costs (energy, wages, raw materials, etc.) and there has been no reduction in demand for your product, the most natural response is to continue to raise prices until you find the clearing price where demand softens.  It is a pipe dream for any central bank to expect that the current situation is going to resolve itself in the near future.

And yet…the major central banks (Fed, ECB, BOE and BOJ) continue to be committed to maintaining ultra-easy monetary policy.  For instance, today’s inflation data from the UK is a perfect case in point.  CPI rose a more than expected 4.2% Y/Y, more than double the BOE’s price target.  Core CPI rose 3.4%, also more than expected and RPI (Retail Price Index, the price series that UK inflation linked bonds track), rose 6.0%, the highest level since 1991.  And yet, the BOE is seemingly no closer to raising rates.  You may recall that despite what appeared to be clear signaling by the BOE they would be raising interest rates at their meeting earlier this month, they decided against doing so, surprising the market and leading to significant volatility in UK interest rate markets.  In fact, BOE Governor Bailey fairly whined afterwards that it was not the BOE’s job to manage the economy.  (If not, what exactly is their job?)  At any rate, the growing concern in the UK is that growth is slowing more rapidly while prices continue to rise.  This has put the BOE in a tough spot and will likely force a decision as to which issue to address.  The problem is the policy prescriptions for each issue are opposite, thus the conundrum.

The bigger problem is that this conundrum exists in every major economy.  The growth statistics we have seen have clearly been supported by the massive fiscal and monetary policy expansion everywhere.  In the US, that number is greater than $10 trillion or 40% of the economy.  The fear is that organic growth, outside the stimulus led measures, is much weaker and if policy support is removed too early, economies will quickly fall back into recession.  In fact, that is the most common refrain we hear from policymakers around the world, premature tightening will be a bigger problem.  Ultimately, a decision is going to need to be made by every central bank as to which policy problem is more important to address immediately.  For the past four decades, the only policy issue considered was growth and how to support it.  But now that inflation has made a comeback, it is a much tougher choice.  We shall see which side the major central banks choose over the coming months, but in the meantime, the one thing which is abundantly clear is that prices are going to continue to rise.

A reasonable question would be, how have markets responded to the latest data and comments?  And the answer is…no change in attitude.  Risk appetite remains relatively robust as the money continues to flow from central banks, although certain risk havens, notably gold, are finding new supporters as fears of significantly faster inflation grow.

So, let’s survey today’s markets.  Equities have had a mixed session with Asia (Nikkei -0.4%, Hang Seng -0.25%, Shanghai +0.45%) and Europe (DAX +0.1%, CAC +0.1%, FTSE 100 -0.3%) all, save China, remaining near all-time highs (in the case of the Nikkei they are merely 31 year highs from after the bubble there), but certainly showing no signs of backing off.  US futures are showing similar price action with very modest movement either side of flat.

Bonds, as well, are little changed and mixed on the day with Treasuries (-0.5bps) catching a modest bid after having sold off sharply over the past week.  In Europe, the price action is similar with Bunds (-0.3bps), OATs (+0.2bps) and Gilts (-0.5bps) all within a few tics of yesterday’s closing levels.  I would have expected Gilts to suffer somewhat more given the UK inflation data, but these days, it appears that inflation doesn’t have any impact on interest rates.

Commodity prices are softer this morning led by oil (-1.3%) and NatGas (-1.75%), although European NatGas is higher by more than 7.3% this morning as Russia continues to restrict flows to the continent.  (I have a feeling that the politicians who made the decision to rely on Russia for a critical source of power are going to come under increasing pressure.)  In the metals markets, industrials are mostly under pressure (Cu -1.0%, Sn -0.1%, Zn -0.8%) but we are seeing a slight rebound in aluminum (+0.6%) and precious metals are doing fine (Au +0.6%, Ag +1.1%).  It seems that inflation remains a concern there.

As to the dollar, it has outperformed a few more currencies than not, with TRY (-1.25%) the biggest loser as the central bank there has clearly made the decision that growth outweighs inflation and is expected to cut interest rates further despite inflation running at nearly 20%.  Elsewhere in the EMG bloc, the losers are less dramatic with MYR (-0.3%) and CLP (-0.3%) the next worst performers.  On the plus side, RUB (+0.8%) is the clear leader, shaking off the decline in oil prices as inflows to purchase Russian bonds have been enough to support the ruble.  Otherwise, there are a handful of currencies that have edged higher, but nothing of note.

In the G10, the picture is also of a few more losers than gainers but no very large moves at all.  surprisingly, GBP (+0.1%) has done very little in the wake of the CPI data and actually SEK (+0.35%) is the best performer on the day.  However, given the krona’s recent performance, where it has fallen more than 4% in the past week, a modest rebound should not be much of a surprise.  Overall, the dollar has retained its bid as evidenced by the euro (-2.8%) and the yen (-2.0%) declining during the past week with virtually no rebound.  It appears that the market continues to believe the Fed is going to be the major central bank that tightens policy fastest and the dollar is benefitting accordingly.

This morning’s data brings Housing Starts (exp 1579K) and Building Permits (1630K), neither of which seem likely to move markets.  Yesterday’s Retail Sales and IP data were much stronger than expected, which clearly weighed on bond markets a bit, and supported the dollar, but had little impact elsewhere.  We hear from seven! Fed speakers today, as they continue to mostly double down on the message that they expect inflation to subside on its own and so it would be a mistake to act prematurely.  There is a growing divide between what the market believes the Fed is going to do and what the Fed says they are going to do.  When that resolves, it will have a large market impact, we just don’t know when that will be.

For now, you cannot fight the dollar rally, but I will say it is getting a bit long in the tooth and a modest correction seems in order during the next several sessions.  Payables hedgers should be picking spots and layering into hedges because the longer-term situation for the dollar remains far more tenuous.

Good luck and stay safe
Adf

Resolute

Posted on by

The narrative is resolute
That though prices did overshoot
They’re certain to fall
And that, above all,
The Fed’s in control, absolute

However, concern is now growing
That growth round the world’s started slowing
Though Friday’s report
On jobs was the sort
To help the bull market keep going

Clearly, my concerns over a weak payroll report were misplaced as Friday’s data was strong on every front, although perhaps too strong on some.  Nonfarm payrolls grew a robust 943K with net revisions higher of 119K for the past two months.  The Unemployment Rate crashed to 5.4%, down one-half percent, and Average Hourly Earnings rose 4.0% Y/Y.  It is the last of these that may generate some concern, at least from the perspective of the transitory inflation story.

While it is unambiguously good news for the working population that their wages are rising, something that has been absent for the past two decades, as with Newton’s first law (every action has an equal and opposite reaction) the direct result of rising wages tends to be rising prices.  So, while getting paid more is good, if the things one buys cost more, the net impact may not be as positive.  And in fact, consider that while the 4.0% annual rise is the highest (excluding the distortions immediately following the  Covid-19 lockdowns) in the series since at least the turn of the century, when compared to the most recent CPI data (you remember, 5.4%) we find that the average employee continues to fall behind on a real basis.

When discussing inflation, notice that the Fed harps on things like used car prices or hotel prices as the key drivers of the recent rise in the data.  They also tend to explain that commodity prices play a role, and that is something they cannot control.  But when was the last time Chairman Powell talked about rapidly rising wages or housing prices as an underlying cause of inflation?  In fact, when asked about whether the Fed should begin tapering mortgage-backed securities purchases sooner because of rapidly rising house prices, he claimed the Fed’s purchases have no impact on house prices, but rather it was things like the temporary jump in lumber prices that were the problem.  Oh yeah, and see, lumber prices have fallen back down so there is nothing to worry about.

Of course, wages are not part of CPI directly.  Rising wages are reflected in the rising prices of everything as companies both large and small find it necessary to raise prices to maintain their profitability.  Certainly, there are some companies that have more pricing power than others and so are quicker to raise prices, but in the end, rising wages result in one of two things, higher prices or lower margins, and oftentimes both.  In the broad scheme of things, neither of these outcomes is particularly positive for generating real economic growth, which is arguably the goal of all monetary policies.

Consider, to the extent rising wages force companies to raise the price of their product or service, the result is an upward bias in inflation that is independent of the price of oil or lumber or copper.  In fact, one of the key features of the past 40 years of disinflation has been the fact that labor’s share of the economic pie has fallen substantially compared to that of capital.  This has been the result of the globalization of the workforce as the addition of more than 1 billion new workers from developing nations was sufficient to keep downward pressure on wages.

Arguably, this has also been one of the key reasons corporate profit margins have risen and stock prices along with them.  Now consider what would happen if that very long-term trend was in the process of reversing.  There is a likelihood of rising prices of goods and services, otherwise known as inflation.  There is also a likelihood of a revaluation of equity prices if margins start to decline. And nothing helps margins decline like rising labor costs.

Consider, also, this is the sticky type of inflation, exactly the opposite of all the transitory claims.  This is the widely (and rightly) feared wage-price spiral.  I am not saying this is the current situation, at least not yet, but that things are falling into place that could easily result in this outcome.

Now put yourself in Chairman Powell’s shoes.  Prices have begun rising more rapidly as companies respond to rising wage pressures.  The employment situation has been improving more rapidly so there is less concern over the attainment of that part of your mandate.  But…the amount of leverage in the system is astronomical with government debt running at record high levels (Federal government at 127%) and all debt, including household and corporate at 400% of GDP.  Do you believe that the economy can withstand higher interest rates of any substance?  After all, in order to tackle inflation, real rates need to be positive.  What do you think would happen if the Fed raised rates to 6%?  And this is my point as to why the Fed has painted themselves into the proverbial corner.  They cannot possibly respond to inflation with their “tools” because the negative ramifications would be far too large to withstand.  It is also why I don’t’ believe the Fed will make any substantive policy changes despite all the tapering talk.  They simply can’t afford to.

Ok, on to the markets.  One of the notable things overnight was the flash crash in the price of gold, which tumbled $73 as the session began on a huge sell order in the futures market, although has since regained $54 and is currently down 1.1% from Friday’s close.  The other things was the release of Chinese CPI (1.0%) and PPI (9.0%), both of which printed a few ticks higher than expected.  Obviously, there is not nearly as much pass-through domestically from producer to consumer prices in China, but that tends to be a result of the fact that consumption is a much smaller share of the Chinese economy.  However, higher prices on the production side, despite the government’s efforts to stop commodity speculation and hoarding, does not bode well for the transitory story.  And while discussing EMG inflation readings, early this morning we saw Brazil (1.45% M/M) and Mexico (5.86% Y/Y) both print higher than forecast results.  Certainly, it is no surprise that both central banks are in tightening mode.

A quick peak at equity markets showed Asia performed reasonably well (Nikkei +0.3%, Hang Seng +0.4%, Shanghai +1.0%) although Europe has been struggling a bit (DAX -0.2%, CAC -0.1%, FTSE 100 -0.4%).  US futures, meanwhile, are either side of unchanged with very modest moves.

Treasury yields have given back 2 basis points from Friday’s post-NFP surge of 7.5bps, although there are many who continue to believe the short-term down trend has been ended.  European sovereigns are also rallying a bit, with Bunds (-1.3bps), OATs (-1.3bps) and Gilts (-3.5bps) leading a screen that has seen every European bond rally today.

Commodity prices are perhaps the most interesting as oil prices have fallen quite sharply (-4.0%) with WTI back to $65.50/bbl, its lowest level since late May.  This appears to be a recognition of the growth of the Delta variant and how more and more nations are responding with another wave of lockdowns and restrictions on movement, thus less travel and overall economic activity.  As such, it should be no surprise that copper (-1.5%) is lower or that the metals space as a whole is under pressure.

Interestingly, the dollar is not showing a clear trend at all today, with gainers and losers about evenly mixed and no particularly large moves.  In the G10, NOK (-0.3%) is the laggard, clearly impacted by oil’s decline, but away from that, the mix is basically +/- 0.1%, in other words, no real change.  In the emerging markets, ZAR (+0.3%) is the leader, although this appears more to be a response to its sharp weakness last week than to any specific news.  And that is the only EMG currency that moved more than 0.2%, again, demonstrating very little in the way of new information.

Data this week brings CPI amongst a bunch of lesser numbers:

Today JOLTS Jobs Openings 9.27M
Tuesday NFIB Small Biz Optimism 102.0
Nonfarm Productivity 3.2%
Unit Labor Costs 0.9%
Wednesday CPI 0.5% (5.3% Y/Y)
-ex food & energy 0.4% (4.3% Y/Y)
Thursday Initial Claims 375K
Continuing Claims 2.88M
PPI 0.6% (7.1% Y/Y)
-ex food & energy 0.5% (5.6% Y/Y)
Friday Michigan Sentiment 81.2

Source: Bloomberg

At this point, the response to the CPI data will be either of the following; a high number will be ignored (transitory remember), and a low number will be proof they are correct.  So, while we may all be suffering, the narrative will have no such problems!

There are a handful of Fed speakers this week as well, with the two most hawkish voices (Mester and George) on the calendar.  Right now, the narrative has evolved to tapering is part of the conversation and Jackson Hole will give us more clarity.  The market is pricing the first rate hike by December 2022 based on the recent commentary.  We shall see.  Until then, I don’t anticipate a great deal as many desks will be thinly staffed due to summer vacations.  Just be careful if you have a large amount to execute.

Good luck and stay safe
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Quite Unforeseen

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When OPEC, a group of fifteen

Producers, all gathered in Wien

Nobody assumed

The meeting was doomed

To failure, t’was quite unforeseen

Alas, for the group overall

The UAE prince had the gall

To strongly demand

Their quota expand

The Saudis, though, wouldn’t play ball

The big story this morning revolves around the failure to agree, by OPEC+, on new production quotas going forward.  While expansion of output was on the agenda as each member was keen to take advantage of the rising price of crude and its products, it seems the UAE demanded a much larger share of the increase than the Saudis wanted to give.  Ordinarily, this type of horse trading takes place in the background as OPEC likes to show its unity, but for some reason, this particular situation burst into plain sight.  Undoubtedly there are many underlying issues between Saudi Arabia and the UAE, but right now, this is the one that matters.  The result has been that oil continues to rise sharply, up another 1.75% this morning taking the gains this year to nearly 60%.  As is frequently the case in a bullish commodity market, the price curve is in steep backwardation, with the front month contracts being significantly more expensive than the outer months.  This is an indication of a lack of short-term supply, something borne out by the continued drawdown of reserves in storage.

What makes this situation so interesting is the fact that the dollar has not fallen sharply while the price of oil has risen.  Historically, rising commodity prices go hand in hand with a weaker dollar, at least versus its counterpart currencies, but that is not really the case this time.  Thus, for those nations that import oil, their local costs have increased more than proportionally as the lack of dollar weakness means it costs much more local currency to procure each barrel.  For instance, since the start of 2021, the Japanese yen has weakened 6.8% and the Swiss franc has fallen 4.1% while oil’s price has soared.  Neither of these nations produces a drop of oil, so their energy costs have climbed substantially.  In the emerging markets, TRY (-14.1%), ARS (-12.2%), PEN (-8.0%) and THB (-7.0%) are the worst performers this year, none of whom have a significant oil industry and all of whom rely on imports for the bulk of their usage.  A weaker currency and higher oil prices are very damaging to those economies.

The question at hand is whether or not this internecine spat will end soon, with some sort of compromise, or if the UAE will stand its ground under increasing pressure.  One thing to consider is that the US shale producers are not likely to come to the market’s rescue in the near term, if ever, as it appears that even at these prices, the capital flowing into the sector to increase production has not expanded, and if anything, given the green initiatives and demands to stop funding fossil fuel production, is likely to decrease.  We may be approaching a scenario where the US, which continues to pump about 11 million barrels/day, will find itself in very good stead relative to many other developed nations that import a higher percentage of their energy needs.  Arguably, this will help the dollar, which means that for some countries, things are only going to get tougher.

As an aside, there is another commodity that has been performing pretty well despite the dollar’s strength, gold.  Here, too, history has shown that a rising dollar price of gold is highly correlated with a weaker dollar on the foreign exchange markets.  But that is not the current situation, as after a very short-term drop in the wake of the FOMC meeting’s alleged hawkishness, gold has rebounded while the dollar has retained virtually all of its gains from the same meeting.  My sense is that there are larger underlying changes in market perception, one of which is that inflation expectations are becoming embedded.

Of course, that is not evident in the bond market, where Treasury yields remain in their downtrend that began in early May in the wake of the massively disappointing NFP report that month.  Since then, yields have fallen more than 20 basis points and show no sign of slowing down.  Oddly, if the market was pricing in a tapering by the Fed, I would have anticipated bond yields to rise somewhat, so this is simply another conundrum in the market right now.  

Turning to the overnight session, one might argue we are looking at a very modest risk-off session.  Equity markets have been desultory with Asia (Nikkei +0.15%, Hang Seng -0.25%, Shanghai -0.1%) not showing much activity while European bourses (DAX -0.4%, CAC -0.3%, FTSE 100 -0.15%) are a bit softer.  Arguably, the European markets have responded to much weaker than expected German data with Factory Orders falling -3.7% ad the ZEW Expectations Survey falling to 63.3, well below the expected 75.2 reading.  Questions about whether or not the global economy has peaked are starting to be asked as stimulus measures fade away.  By the way, US futures are essentially unchanged at this hour.

While today’s Treasury movement has been nil, we are seeing yields decline across Europe with Bunds (-1.5bps), OATs (1.9bps) and Gilts (-1.1bps) all seeing a bit of demand on the back of waning risk appetite.  Remember, too, that the inflation impulse in Europe remains far less substantial than that in the US.

Aside from oil (+1.75%) and gold (+0.8%), the rest of the commodity bloc is also pretty firm this morning with Copper (+1.5%) and Iron ore (+1.6%) leading the base metals higher.

Finally, in the FX market, the best way to describe things would be mixed.  The RBA met last night and was more hawkish than anticipated.  They not only indicated they were going to reduce the amount of QE purchases when the current program comes up for renewal, but they appear to be ending YCC as well, explaining that they would not be supporting the November 2024 bonds when they become the 3-year maturity.  Not surprisingly, we saw AUD (+0.6%) rally, which dragged NZD (+0.8%) up even more as traders speculate the RBNZ is going to raise rates as well.  Away from that, though, the bulk of the G10 bloc was softer led by NOK (-0.55%), which given oil’s continued rise makes little sense.  At this point, I will chalk it up to trading technicals as I see no strong rationale.  As to the rest of the bloc, modest declines are the name of the game.

Emerging markets have also seen similar mixed price action with ZAR (+0.25%) the leading gainer on the back of gold’s strength while HUF (-0.65%) is the laggard as the market awaits comments from the central bank regarding its green policy ideas.  The next weakest currency in this bloc is PHP (-0.5%) as the central bank confirmed it would not be reducing stimulus until it had further confidence the economy there would be picking up.

On the data front, there are only a few releases due although we do see the FOMC Minutes tomorrow.

TodayISM Services63.5
WednesdayJOLTs Job Applications9313K
 FOMC Minutes 
ThursdayInitial Claims350K
 Continuing Claims3325K

Source: Bloomberg

Aside from this limited information, we hear from just one Fed speaker tomorrow.  Perhaps the market will have the opportunity to make up its own mind about where things are going to go.

At this point, the Fed narrative remains that inflation is transitory and that they will continue to support the economy going forward.  However, there is a group of FOMC members who clearly believe that it is time to cut back on QE.  That will be the major discussion for the next several months, to taper or not, and if so, how quickly it will occur.  My view continues to be that the core of the Fed is not nearly prepared to taper QE purchases as they know that the ongoing expansion of Federal debt will require the Fed to remain an active part of the market lest things get more concerning for bond traders.

As to the dollar, it remains in its trading range having reached the top of that range last week.  I would not be surprised to see a bit of dollar weakness overall, if for no other reason than the dollar is likely to slip back toward the middle of its range.

Good luck and stay safe

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