Tag Archives: #hawks

Subterfuge

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The narrative right now is run
By hawks who think Warsh is the one
To raise short-term rates
Right out of the gates
And so, they’re long bucks by the ton

Thus, futures positions are huge
With no effort at subterfuge
But if they are wrong
About being long
The hawks will have all been the stooge

In an otherwise quiet session, this morning I am going to borrow from Ole Sloth Hansen, the futures maven at Saxo Bank.  He publishes a Substack that is well worth reading if you are actively involved in the markets as he breaks down futures positions and offers context.  This morning I am going to juxtapose those positions with my views, which are diametrically opposed to the way the market is currently positioned.

Starting with the FX market, he has created a wonderful chart showing that the net non-commercial long USD position against eight major currencies has reached 10-year highs.  Interestingly, the DXY is not anywhere near those highs, although it appears that is the growing expectation of many traders.

Arguably, this is based on the idea that Chairman Warsh is Paul Volcker redux and will be quite hawkish going forward.  Now, I cannot tell if this is the narrative because, absent forward guidance, narrative writers must now think on their own and are incapable of doing so, or if they truly believe that despite all the talk that rising oil prices were going to feed through to inflation readings, declining oil prices won’t have the same impact on the way down.

But it is not just the FX trading community that is on board with this story, so too is the short-term interest rate trading community.  While LIBOR has been forced out of existence, SOFR (Secured Overnight Funding Rate) is the new benchmark in interest rate markets and, naturally, there is an active futures market there as well.  As you can see from the below chart, also from Mr Hansen, the current positioning is strongly expecting higher short-term interest rates.

This is completely in accord with the Fed funds futures market where the market continues to price a 25% probability of a hike at the end of July and a virtual certainty of a hike by October.  By my calculations, as per the chart from cmegroup.com below, the market is pricing about 30bps of rate hikes by the December meeting.

Or course, by now you know that my view is the Fed will not be hiking rates at all, and as measured inflation slides back (just look around the world and at oil prices) the narrative will belatedly shift to the need willingness to reduce rates on Warsh’s part and all these market positions will adjust.  

My longer-term positive view of the dollar is based on the ongoing investment inflows into the US, for real investment, not merely equity market participation, and nothing has happened to change that view.  In fact, the announcement yesterday by Toyota that they will be expanding their San Antonio truck and SUV plant with a $3.6 billion investment is just the latest in a series of these announcements.  But that is not the carry trade driving things.  In fact, ironically, we could easily see US rates slide a bit as the dollar rallies on natural investment demand rather than financial demand.  As well, if I am correct, the Fed funds futures market is going to head back to pricing no rate hikes, perhaps as soon as next week after the CPI data is released.

I think the lesson is that the narrative writers need to bone up on their understanding of macroeconomics and international finance as the central bank policy driver may not be the future.  Certainly, if Mr Warsh has anything to say about it, and he does, that will likely be the case.

Which takes us to the overnight session. The most excitement overnight was for Belgium as they completely outplayed the USMNT in a 4-1 victory in Seattle.  But otherwise, the story that Iran fired two missiles at ships heading through Hormuz helped support oil prices, but as I type, they are higher by just 0.7% (~50¢/bbl) so not really very much.  The interesting discussion in the oil market this morning is the fact that Iranian oil, which is no longer sanctioned, cannot seem to find any buyers with some 58 million barrels in floating storage and no takers.  Meanwhile, despite ongoing buying by central banks around the world, gold (-0.5%) continues to struggle, although appears to be putting in a base and silver (-1.4%) is suffering as well.  

In the bond market, yields are creeping higher with both Treasuries and European sovereigns all higher by 2bps this morning with a similar move by JGBs overnight.  My take is this is less of an inflation concern than a supply concern.  Certainly, there is no indication that the US, Europe or Japan are about to slow down their fiscal stimulus, with Europe now further ramping up its defense spending as the US pressures NATO further.  To me, this is where the rubber will meet the road as if Warsh really does seek to reduce the Fed’s balance sheet, it is not clear where buyers are going to be found to replace them.  I suspect we will see more regulatory freedom for banks and insurance companies to hold Treasuries without capital penalties, but that is a big hole to fill.  

In the equity markets, yesterday’s US rally was followed by a reversal in Asia with Korea (-4.9%) leading the way lower on the back of weakness in SK Hynix stock despite stellar earnings.  But that dragged down the entire region (Japan -2.1%, China -1.0%, HK -0.5%, Taiwan -2.3%) and various declines everywhere else except Singapore (+1.4%) although I can find no specific catalyst for that outlier move.  In Europe, things are more mixed with Germany (-0.7%) under pressure although there is modest strength in the UK (+0.3%), France (+0.2%) and Spain (+0.1%).  All the talk here is about defense spending, although one would have thought that would help Germany the most.  As to US futures, at this hour (7:55), NASDAQ futures are following Asia lower, -1.3%, but the other indices are little changed.

Finally, the dollar is generally a bit stronger this morning, at least against its G10 counterparts, although JPY (+0.1%) is holding up.  But the dollar’s gains are minimal, about 0.1% to 0.2%, so it is difficult to get too excited.  In the EMG bloc KRW (+1.0%) is the clear leader after the country expanded trading hours in the currency markets, and there has been modest strength in BRL (+0.4%) and INR (+0.4%) although neither has seen any major policy changes.

On the data front, yesterday’s ISM Services data was right on the button at 54.0.  This morning we see the Trade Balance (exp -$78.5B) and that’s it.  The hawkish Fed story continues to be the most popular, and until we see some data that can undermine that story, I expect it will remain in place.  Tomorrow’s FOMC Minutes should be interesting as there was obviously a lot of back and forth at the meeting, but since we have already heard further from Mr Warsh, and it is way too early to hear back from the task forces, I suspect we are in for more quiet markets for now.

Good luck

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No Paradox

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In Europe, the ECB hawks
Explained in their most recent talks
The rising of late
In THE 10-year rate
Was normal and no paradox

At home, hawks are also reduced
To cheering the 10-year yield’s boost
Since Powell’s a dove
And rules from above
The hawks can’t shake him from his roost

In a world where every central bank is adding massive amounts of liquidity, how can you determine which central bankers are hawks and which are doves?  Since no one is allowed to make the case that short-term rates should be raised to try to slow down rising inflation, the next best thing for the hawks to do is to cheer on the rise in longer term yields.  And that continues to be the number one story in markets around the world, rising bond yields.  Yesterday saw Treasury yields rise 9 basis points as investors continue to see US data point to rising inflationary pressures.  The ISM Services Price Index rose to its highest level since 2008, just like we saw in the Manufacturing Index on Monday.  Even official inflation measures continue to print a bit higher than forecast, a sign that underlying price pressures are quite widespread.

In the past, this type of economic data would encourage the hawkish contingent of every central bank to argue for raising the short-term rate.  But hawkish views appear to have been written by Dr Seuss, as they have been removed from the canon of financial discussion.  Which leaves the back end of the curve the only place where they can express their views.  And so, we now hear from Klaas Knot, Dutch central bank president that rising government bond yields are a “positive story”, while Jens Weidmann, Bundesbank president explained that these moves are not “a particularly worrisome development.”  We have heard the same thing from Fed speakers as well, although not universally, as the doves, notably Lael Brainerd, hint at Fed action to prevent an unruly market.  My take is an unruly market is one that goes in the opposite direction to their desires.

But despite the central bank commentary, it is becoming ever clearer that inflationary pressures are rising around the world.  We have spent the past 40 years in an environment of constantly decreasing inflation as a combination of globalization and technological advancement have reduced the cost of so many things.  And while technology continues to march forward, globalization is under severe attack, even from its previous political cheerleaders.  This is evident in the current US administration, where strengthening and localizing supply chains is a goal, something that will clearly increase costs.  Add to that increased shipping costs alongside capacity shortages and rising energy costs, and you have the makings of a higher price regime.  (An anecdote on rising price pressures: a friend of mine who lives in Paris told me the prices of the following foods; fresh salmon €60/kg, 1 grapefruit €2.25 and 1 avocado €2.65.  I checked my supermarket app and found the following prices here in New Jersey; fresh salmon $9.99/lb, 1 grapefruit $1.00 and 1 avocado $2.50.  Prices are high and rising everywhere!)

The final piece of this puzzle is broad economic activity, which the data continues to show has seen a real burst in the US, although there is still concern over the employment situation.  Every survey has shown the US economy growing rapidly in Q1 with the Atlanta Fed’s GDPNow forecast currently at 10%.  Adding it all up leads to the following understanding; it is not only the Fed that is willing to run the economy hot, but every G10 central bank, which means that monetary support will continue to flow for years to come.  Combining that activity with the massive fiscal support and the still significant supply bottlenecks that were a result of the government shutdowns in response to Covid brings about a scenario where there is a ton of money in the system and not enough goods to satisfy the demand.  If central banks don’t tap the breaks, rising prices and price expectations will lead to rising yields, and ultimately to declining equities.  The only asset class that will continue to perform is commodities, because owning “stuff” will be a better trade than owning paper assets.  And that’s enough of those cheery thoughts.

On to today’s markets, where, alas, risk is being jettisoned around the world.  After yesterday’s tech led selloff in the US, Asian equity markets really got hammered (Nikkei -2.1%, Hang Seng -2.1%, Shanghai -2.1%) and European markets are also under the gun (DAX -0.45%, CAC -0.3%, FTSE 100 -1.0%).  US futures?  All red at this hour, down about 0.3%, although that is off the lows seen earlier this morning.

Bond yields, meanwhile, despite my discussion of how they are rising, have actually slipped back a bit this morning in classic risk-off price action.  So, Treasuries (-1.9bps), Bunds (-2.6bps), OATs (-2.1bps) and Gilts (-4.1bps) are all rallying.  But this is not a trend change, it is merely indicative of the fact that now that yields have backed up substantially, the concept of government bonds as an effective risk mitigant is coming back in vogue.  After all, when 10-yr Treasuries yield 0.7%, it hardly offers protection to a portfolio, but at more than double that rate, it is starting to help a little in times of stress.

Commodity prices are mixed this morning with oil taking back early session losses to sit unchanged as I type, but base metals in the midst of a modest correction after a remarkable rally for the past several months.  This morning copper (-4.1%) and Nickel (-8.2%) are leading the way lower, but with the ongoing economic activity and absence of new capacity, these are almost certainly temporary moves.  Gold, which has been under significant pressure lately seems to have found a floor, perhaps only temporarily, at $1700, but given the dollar’s ongoing strength, it cannot be surprising gold remains under pressure.

As to the dollar, I would say it is very modestly stronger today, although what had earlier been virtually universal has now ebbed back a bit.  In the G10, CHF (-0.4%) and JPY (-0.3%) are the worst performers, which given the risk attitude is actually quite surprising.  I think the Swiss story is actually a Polish one, where Poland has refused to support local banks who took out CHF loans and have been suffering from currency strength far outstripping the interest rate benefits.  It seems, concern is growing that these loans may be restructured and ultimately impact the Swiss banks and Swiss economy.  Meanwhile, the yen’s weakness stems from a poor response to a 30-year bond sale last night, where yields rose 3.5 bps amid a very weak bid-to-cover ratio for the sale.  Perhaps even the Japanese are getting tired of zero rates!  But away from those two currencies, the rest of the bloc is +/- 0.2% or less, indicating nothing of real interest is going on.

EMG currencies are also mixed with Asian currencies suffering amid the broad risk off environment overnight and CE4 currencies lower on the back of euro weakness.  On the plus side, BRL (+0.7%) and MXN (+0.6%) are the leading gainers, which appears to be an ongoing reaction to aggressive central bank of Brazil intervention to try to prevent further weakness there.  In this space too, the broad risk appetite will continue to remain key.

On the data front we see a bunch of stuff starting with Initial Claims (exp 750K) and Continuing Claims (4.3M), but we also see Nonfarm Productivity (-4.7%), Unit Labor Costs (6.6%) and Factory Orders (2.1%) this morning.  Perhaps of more importance we hear from Chairman Powell today, right at noon, and all eyes and ears will be focused on how he describes recent market activity as well as to see if he hints at any type of Fed response.  Many pundits, this one included, believe there is a cap to how high the Fed will allow yields to rise, the question is, what is that cap.  I have heard several compelling arguments that 2.0% is where things start to become uncomfortable for the Fed, but ultimately, I believe that it will depend on the data.  If the data starts to show that the economy is under pressure before 2.0% is reached, the Fed will step in at that time and stop the madness.  Until then, as we have heard from central bankers worldwide, higher yields in the back end are a good thing, so they will continue to be with us for the foreseeable future.  And yes, that means that until US inflation data starts to print higher, and real yields start to decline, the dollar is very likely to retain its bid.

Good luck and stay safe
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