The first thing we saw yesterday
Was ADP led to dismay
But Treasury news
Adjusted some views
And stocks started trading okay
However, t’were two things we learned
First NYCB stock was spurned
Now, you may recall
That their greatest haul
Was Signature Bank, which was burned
And lastly Chair Powell, at two
Explained what he’s likely to do
They’re not cutting rates
As both their mandates
Remain far ahead in their view
Just when you thought it was safe to go back in the water…
I am old enough to remember when there was a growing certainty that not only was the Fed virtually guaranteed to cut rates by the May meeting, but the March meeting was very much on the table. After all, inflation was below their 2.0% target (if you look at the recent 6-month run rate anyway) and therefore they just had to cut rates or stock prices might fall! Or something like that. But somehow, Jay and the FOMC missed that memo. Instead, what they told us was [my emphasis];
“The Committee seeks to achieve maximum employment and inflation at the rate of 2 percent over the longer run. The Committee judges that the risks to achieving its employment and inflation goals are moving into better balance. The economic outlook is uncertain, and the Committee remains highly attentive to inflation risks.
In support of its goals, the Committee decided to maintain the target range for the federal funds rate at 5-1/4 to 5-1/2 percent. In considering any adjustments to the target range for the federal funds rate, the Committee will carefully assess incoming data, the evolving outlook, and the balance of risks. The Committee does not expect it will be appropriate to reduce the target range until it has gained greater confidence that inflation is moving sustainably toward 2 percent. In addition, the Committee will continue reducing its holdings of Treasury securities and agency debt and agency mortgage-backed securities, as described in its previously announced plans. The Committee is strongly committed to returning inflation to its 2 percent objective.”
In other words, while it is highly unlikely that they will need to hike rates further, unlike the markets or the punditry, Powell has little confidence that they have won the inflation battle and rate cuts remain merely a distant prospect. Certainly, there was no obvious concern that interest rates are “too” high at this time. In other words, this was a much more hawkish statement, and Powell’s answers in the press conference were in exactly the same vein. Memories of the dovish December meeting have faded from view. And this was the denouement to quite a day, one which gave us so much new information.
Things started with a weaker than expected ADP Employment result, just 107K, although that data point’s correlation to NFP has been diminishing of late. Regardless, it was the type of softness that got people primed for a dovish Fed. Then, the QRA indicated that the Treasury will be issuing what appears to be about $45-$50 billion in new coupons this quarter to fund a $400 billion or $500 billion budget deficit. The balance of that will be via T-bills which means that while the ratio is not as aggressively leaning toward T-bills as last quarter, it is still miles above the historical rate of 20% ish. Those two stories got bond bulls hyped, although equity markets struggled on some weak earnings numbers.
And then we heard from New York Community Bank (NYCB), which you may recall, was the lucky recipient of the Signature Bank assets last March. Well, it turns out they made a hash of things, losing a bunch of money with some pretty bad loan impairments added on to increased capital requirements because they grew to a new, larger risk-weighting tier after the acquisition. At this time, there is no indication they are about to go bust, but the question has been asked a lot as the stock cratered and investors ran into Treasury debt just to be safe. As it happens, the stock, which had basically doubled over the past year after buying Signature, has reverted to its pre-acquisition price and that added jitters to everyone’s views. PS, those loan impairments were CRE based which naturally leads to the question of what is going on with other regional banks.
Finally, during the press conference, Chairman Powell was clear that a March rate cut was highly unlikely and that was the final nail in the equity market’s coffin. So, the NASDAQ led the way lower, falling -2.2% while the S&P 500 tumbled -1.6%. At the same time, 10-year yields dropped like a stone, down 12bps to 3.91%.
Looking ahead, I wonder how all those folks who were certain the Fed HAD to cut because policy was just TOO TIGHT for their liking will reframe their narrative. To my eye, yesterday’s equity declines are a blip and will not even register at the Eccles Building. There is a bit of irony in that the doves need now eat so much crow.
Ok, on to this morning, where the overnight price action saw another mixed picture in Asia, but this time with Japan (Nikkei -0.75%) sliding while Chinese shares (Hang Seng +0.5%, CSI +0.1%) edging higher. There was yet another announcement of a bit of further fiscal support from the Chinese government, but Xi remains reluctant to bring out the bazookas. European shares are also mixed with gains in the UK and Spain and losses in France and Germany. PMI data showed that the Flash numbers were pretty much spot on and all of Europe remains well below 50.0 except Norway (50.7) which benefits from its oil industry. It remains very difficult to get excited about the Eurozone’s economic prospects these days which should ultimately weigh on the ECB to cut rates sooner and the euro to suffer in that case. As to US futures, after a wipeout yesterday, this morning they are firmer by about 0.5% at this hour (6:45).
In the bond market, after yesterday’s Treasury yield collapse, 10-year yields are higher by 3bps this morning and European sovereigns have risen about 4bps on average. This movement is more a response to the large move yesterday rather than a result of new information. Overnight, JGB yields slipped 4bps, clearly following in the footsteps of Treasury yields.
As to commodities, oil (+1.0%) has bounced after a weak session yesterday that was driven by demand worries. But tensions in the Middle East seem to be reasserting themselves with several stories in the press this morning regarding the danger to the world from a potential collapse in shipping capabilities. The ongoing Houthi attacks in the Red Sea are starting to really take their toll on supply chain situations. This is not only bad for inflation readings but could well impair the ultimate delivery of critical things like oil, thus driving its price even higher. As to the metals markets, they are all under pressure this morning with gold holding on best given its haven status but all the industrial metals lower by 1% or more.
Finally, the dollar is coming up roses this morning. While in the early going yesterday, before the FOMC meeting, the dollar broadly sold off on the softer ADP and dovish QRA, Powell changed everything, and the dollar reversed course in the middle of the day and rallied back nicely. This is true against virtually all its G10 and EMG counterparts. The weakest members are AUD (-0.7%) after weak housing data Down Under added to thoughts of a rate cut coming soon. As well, we see GBP (-0.4%) just ahead of the BOE meeting where expectations are for a more dovish statement although no policy change. But we are seeing weakness in CLP (-1.3%) on the back of that weak copper price and weakness in ZAR (-0.4%) on the weak metals complex as well. Given the hawkish tilt from Powell yesterday, unless there is a concerted effort by the Fed speakers that will be flooding the tape over the coming weeks to reverse that course, I suspect the dollar will benefit in the near-term.
On the data front, this morning brings Initial (exp 212K) and Continuing (1840K) Claims, Nonfarm Productivity (2.5%), Unit Labor Costs (1.6%) and ISM Manufacturing (47.0). With NFP tomorrow, I expect that the productivity and ULC data should be of the most interest as they will play most deeply into the Fed’s thinking. Improved productivity implies that there is less reason to cut interest rates as the “neutral rate” should be higher than previously thought. In fact, that dynamic would be very positive for the dollar, and interestingly, for the equity market as well as it would be a clear boost to earnings potential. We shall see how it turns out.
Good luck
Adf
Tag Archives: #hawkishness
The Doves Will Be Shot
Inflation was just a touch hot
And certainly more than Jay sought
So, later today
What will the Fed say?
My sense is the doves will be shot
Instead, as Jay’s made manifest
Inflation is quite a tough test
So, higher for longer
Or language much stronger
Is like what he’ll say when he’s pressed
Let’s think a little outside of the box this morning, at least from the perspective of virtually every pundit and their beliefs about what will happen at the FOMC meeting today. At this point, most of the punditry seems to believe that Powell cannot be very much more hawkish, especially since the market is expecting comments like inflation is still too high and the Fed will achieve their goal. So, there is a growing camp that thinks any surprise can only be dovish, since if he doesn’t push back hard enough or talk about loosening financial conditions being a concern, the equity market response will be BUY STONKS!!!
But what if, the thing Powell really wants, or perhaps more accurately needs, is not a soft landing, but a full-blown recession! Think about it. As I have written repeatedly, the idea that the Fed will cut rates by 125bps next year because growth is at 1.5% or 2.0% and inflation has slipped to 2.5% seems like quite an overreaction. But given the current US debt situation ($34 trillion and counting) and the fact that the cost of carrying that debt is rising all the time, what would get the Fed to really cut rates? And the only thing that can do it is a full-blown, multiple quarters of negative GDP growth, rising Unemployment Rate, recession. If come February or March, we start seeing negative NFP numbers, and further layoff announcements as well as declining Retail Sales and production data, that would get the Fed to act.
At least initially, we would likely see inflation slide as well, and with that trend plus definitive weakness in the economy, it would open the door for some real interest rate cuts, 400bps in 100bp increments if necessary. Now, wouldn’t that take a huge amount of pressure off Treasury with respect to their refi costs? And wouldn’t that encourage accounts all over the world to buy Treasuries so there would be no supply issues? All I’m saying is that we cannot rule out that Powell’s master plan to cut rates is to drive the economy into a ditch as quickly as possible so he can get to it. In fact, it would open the door to restart QE as well.
This is not to say that this is what is going to happen, just that it is not impossible, and I would contend is not on anyone’s bingo card. Now, Powell will never say this out loud, but it doesn’t mean it is not the driving force of his actions. Powell is incredibly concerned with his legacy, and he has made abundantly clear that he will not allow his legacy to be the second coming of Arthur Burns. Instead, he has his sights on the second coming of Paul Volcker, the man who killed the 1970s inflation dragon. St Jerome Powell, inflation slayer, is what he wants as his epitaph. And causing a recession to kill inflation and then cut rates is a very clever, non-consensus solution.
How will we be able to tell if I’m completely nuts or if there is a hint of truth to this? It will all depend on just how hard he pushes back on the current narrative. Yesterday’s CPI results could best be described as ‘sticky’, not rebounding but certainly not declining further. Shelter costs continue apace at nearly 6% Y/Y and have done so for more than 2 years. I was amused this morning by a chart on Twitter (I refuse to call it X) that showed CPI less shelter rose at just 1.4% with the implication that the Fed needs to start cutting rates right away. The problem with that mindset is that shelter is something we all pay, and there is scant evidence that housing markets are collapsing. In fact, according to the Case Shiller index, they are rising again. I would contend that there is plenty of evidence to which Powell can point that makes his case for an economy that is still running far too hot to allow inflation to slide back to their target. And that’s what I expect to hear this afternoon.
Speaking of recession, let us consider the situation in China, where despite the CCP’s annual work conference just concluding with some talk of building a “modern industrial system” the number one goal this year, thus boosting domestic demand, they announced exactly zero stimulus measures to help the process. Data from China overnight showed that their monthly financing numbers were all quite disappointing compared to expectations and the upshot was a further decline in Chinese and Hong Kong equity markets. This ongoing economic weakness and the lack of Xi’s ability or willingness to address it continues to speak to my thesis that commodity prices will remain on the back foot. If you combine the high interest rate structure in the G10 with a weaker Chinese economy, the direction of travel for energy and base metals is likely to be lower. The one exception here is Uranium, where there is an absolute shortage of available stocks and a renewed commitment around the world to build more nuclear power plants.
At the same time, Europe remains pretty sick as well, with Germany leading the entire continent into recession, and likely dragging the UK with it. Germany, France, Norway, the UK and others are all sliding into negative growth outcomes. While Chairman Powell will continue to push back on the idea of rate cuts soon, I expect that tomorrow, when both the ECB and BOE meet, they will open the door to rate cuts early next year. Inflation in both places has been falling sharply and there is no evidence that Madame Lagarde or Governor Bailey is seeking to be the next Paul Volcker. Both will blink with the result that both the euro and the pound should feel pressure.
Summing it all up, today I think we get maximum hawkishness from the Fed with Powell pushing back hard on the market pricing. Initially, at least, I expect we could see yields rise a bit and stocks sell off while the dollar continues its overnight rise. But I also know that there are far too many people invested in the idea that the Fed must cut soon, and they will be back shortly, buying that dip until they are definitively proven wrong.
As to the rest of the overnight session, aside from China’s weak performance, South Korea also lagged, but the rest of the APAC region saw modest gains. Europe, meanwhile, is all green, although it is a very pale green with gains on the order of 0.2%, so no great shakes. Finally, US futures are firmer by 0.1% at this hour (7:15) after yesterday’s decent gains.
Bond yields are sliding this morning, down 2bps in the US and falling further in Europe with declines of between -3bps and -6bps on the continent as investors and traders there start to price in a more aggressive downward path for interest rates by the ECB. UK yields are really soft, -9bps, after GDP data this morning was disappointing across the board, especially the manufacturing data.
Oil prices (+0.45%) which got slaughtered yesterday, falling nearly 4%, are stabilizing this morning, as are gold prices, which fell yesterday, but not quite as much as oil. However, the base metals complex continues to feel the pressure of weak Chinese demand. I continue to believe that there are structural supply issues, but right now, the macro view of weak economic activity is the main driver, and it is driving prices lower.
Finally, the dollar is firmer this morning as weakness elsewhere in the world leaves fewer choices for where to park funds. While the movement has not been overly large, it is quite uniform across both G10 and EMG currencies. The laggards have been NZD (-0.6%) after a softer than expected CPI reading and ZAR (-0.6%) on the back of weakening metals prices. If I am correct about the path going forward, the dollar should perform well right up until the Fed responds to much weaker economic activity and starts to cut rates aggressively. At that point, we can see a much sharper decline in the greenback.
Ahead of the FOMC meeting, this morning we get November PPI (exp 1.0%, 2.2% core) which would represent a small decline from last month’s data. We will also see the EIA oil inventory data, which has shown a recent history of builds helping to drive the oversupply narrative there.
At this point, it is all up to Jay. I suspect that markets will be quiet until then, and it will all depend on the statement, the dot plot and the presser.
Good luck
Adf
fxpoetry 