Tag Archives: #higherdollar

Savants Disagree

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The Senate completed their vote
And so, BBB, though there’s bloat
Will soon become law
As Dems say pshaw
While lacking a doctrine, keynote
 
So, eyes now turn to NFP
The key for the FOMC
The JOLTs showed that gobs
Of ‘vailable jobs
Exist, though savants disagree

 

Market activity continues to demonstrate lower volumes and despite several competing political narratives, price action remains muted overall.  The biggest news of late is the Senate passed their version of President Trump’s BBB last night and now it goes to committee for reconciliation before getting to the president for signing.  Of course, given the mainstream media’s complete antagonism toward the president, the headlines this morning refer to the problems the Republicans will have agreeing terms between the two houses, and I’m sure it will be difficult.  However, based on everything that President Trump has done to date, I expect it will get completed.  While perhaps not by Friday, probably by next week.

This matters to markets because it will help set the tone for government spending and the potential companies that will benefit, as well as those that will be negatively impacted, based on the change in focus from that of the Biden administration.  

At this point, it is impossible to forecast with any certainty how things will evolve, especially with respect to issues like the budget deficit and debt issuance.  While yesterday, Treasury Secretary Bessent did explain that they were going to continue to focus on short-term issuance, if (and it’s a big if) the bill does goose economic activity in the US, it is quite possible that faster GDP growth increases tax collections and reduces net government spending and the deficit.  I would estimate that view is not discounted at all in markets at this time given the constant messaging from media and the punditry that not only are people going to starve to death and lose their medical care because of this bill, but that it is unaffordable and will bankrupt the country.  Something tells me the results will be slow acting, although if the government does continue its deportations and stops subsidizing too-expensive green energy projects, we could see less government spending.  We shall see.

But markets need a focus and tomorrow’s NFP is as good as it gets.  Chairman Powell has been attending the ECB’s summer symposium and, in his speech, yesterday he essentially reiterated his views that the Fed will continue to watch and wait on rates as there is still concern that tariffs may drive inflation higher.  As to jobs, they are watching the situation closely, but thus far, the labor market has held up.  Proof of that idea was evident in yesterday’s JOLTs Job Openings data which showed a surprising jump of more than 300K new job listings available.  I haven’t seen a rationale yet, but perhaps it is related to the self-deportations by illegal immigrants who have left businesses with numerous vacancies.  The weekly claims data, while above its lowest levels lately, continues to run at very modest numbers on a long-term perspective as can be seen in the chart below with data from the Department of Labor.  If the job market holds up, I don’t see the Fed cutting rates despite President Trump’s ire.

Also, at Sintra was BOJ Governor Ueda who explained that Japanese policy rates were substantially lower than neutral and that inflation would likely continue creeping higher over time.  I guess we cannot be surprised that the yen (-0.5%) has slipped in the wake of those comments.  The final noteworthy comments from Sintra were from BOE governor Bailey who explained that despite sticky inflation, more rate cuts were on the way, helping to undermine the pound (-0.4%) this morning.

But there is one final thing to discuss regarding the Sintra meeting, and that is how many central bankers were suddenly concerned that their currencies were getting “too strong”!  We have been hearing about the dollar’s decline in the first half of the year as though it was a signal the US was in permanent decline.  Of course, given the nature of FX trading, a weaker dollar can also be seen as strength in other currencies. (To be clear, all fiat currencies continue to weaken vs. stuff as evidenced by the fact that inflation continues to be positive everywhere in the world, except perhaps Switzerland and China right now.)  However, I could not help but laugh at the ECB comments from several board members, that if the euro were to rise any further it could become a problem for the Eurozone economies.  All their models show that if a major export destination raises tariffs, their own currencies should decline to offset those tariffs.  Alas, once again, their models are not giving them answers that reflect the reality in markets.  And given Europe has built their economies on export reliance, a strong currency is a problem.

We must distinguish between a stronger exchange rate and a strong case to own a currency, especially as a reserve asset, but the two have historically been highly correlated.  As I have repeatedly explained, the dollar’s decline this year is neither anomalous nor particularly large in the broad scheme of things.  As well, it is exactly what the administration is seeking as it helps the competitiveness of US companies on the world stage.  However, my take is that at some point soon, the dollar will find a bottom.  I indicated a move to 90 on the DXY would be possible, and I think that is probably still true, although given the growing net short positions in USD vs. other currencies, the short squeeze will be spectacular when it arrives!

Ok, let’s see if we can get through the overnight activity without falling asleep.  Yesterday’s mixed US session was followed by a mixed session in Asia (Nikkei -0.6%, Hang Seng +0.6%, CSI 300 0.0%) with a mixture of modest gains and losses across the rest of the region, all on low volumes.  In Europe this morning, bourses are firmer led by the CAC (+1.1%) and Spain’s IBEX (+0.75%) as hopes for further rate cuts from the ECB dominate discussions.  As to US futures, they are modestly higher at this hour (7:30), about 0.15%.

In the bond market, after stronger than expected JOLTs data and ISM data, yields are backing up with Treasuries (+4bps) leading the way although both Germany (+5bps) and the UK (+6bps) are seeing selling pressure as well.  However, the rest of European sovereigns have only seen yields edge 1bp higher.  The only noteworthy comments I saw were from the Italian FinMin who explained Italy would be maintaining its fiscal prudence.  Not surprisingly, given Ueda-san’s comments, JGB yields rose 4bps overnight as well.

In the commodity space, oil (+1.25%) continues to drift higher as it tries to fill the gap seen last week.

Source: tradingeconomics.com

Apparently, the fact that supply seems to be rising rapidly has not dissuaded traders from the view that the ‘proper’ price range is $65-$75 rather than my belief of $50-$60.  But right now, they are looking smart.  In the metals markets, we continue to see support as the entire decline in the gold price at the end of June has been recouped and we are modestly higher this morning across all the metals (Au +0.1%, Ag +0.6%, Cu +0.4%, Pt +2.2%) with platinum merely showing its volatility due to lack of liquidity.

Finally, the dollar is firmer this morning against every one of its G10 and major EMG counterparts with the euro and pound (both -0.4% now) setting the tone.  Perhaps the best performer this morning is INR (-0.1%) which seems to be benefitting from the news that a trade deal is almost complete there.  As to trade with the Eurozone, that deal seems a bit further away, although I did see something about a European recognition that US tariffs would be, at a minimum, 10%.  At least for today, I haven’t read anything about the dollar’s ultimate demise!

On the data front, today brings ADP Employment (exp 95K) and then the EIA oil inventory data.  There are no Fed speakers either, so quite frankly, absent something newsworthy from DC, I suspect this will be a quiet session ahead of tomorrow’s NFP.  I guess the dollar is not dead yet.

Good luck

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A Weapon of War

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The Hammer’s a weapon of war
Just ask those who fought against Thor
At midnight on Friday
Iran learned the hard way
That Trump wields one too when called for
 
The interesting thing early on
Is this clearly ain’t a black swan
While oil did rise
Which was no surprise
Most risk gave an aggregate yawn

 

Obviously, the big news this weekend was the extraordinary attack and destruction of Iran’s three key nuclear enrichment and engineering sites.  While this poet has opinions, since I am just like the rest of you, limited to the peanut gallery and with no voice in the matter, they are not relevant for this discussion.  However, what is relevant is the early movement in markets once they reopened Sunday night in NY.  While it is no surprise that oil’s price rose as you can see below, the early 2.2% gain is pretty lackluster for the alleged (by some) beginning of WWIII.

Source: tradingeconomics.com

As to the rest of the markets early price action, it’s largely what you would have expected directionally, although unimpressive overall with equity indices modestly lower, about -0.35%, the dollar modestly higher, about 0.2%, and bonds little changed.  Gold, too, is little changed.  It appears that, at least initially, the market was anticipating something like this as you can see that even after the oil price spike, it didn’t reach the levels seen on Friday.

With two days to think it all through
Most traders appear to eschew
The idea that war
Is what is in store
Instead, buy more stocks is their view

 

So, as we wake up Monday morning, despite all the weekend news and the fear mongering thus far, and even though Israel and Iran continue to trade missile fire, the early consensus is that we have seen the worst already.  Iran’s parliament voted to block the Strait of Hormuz, but they have no power to drive actions, that resides with the Supreme Council and as of yet, they have not acted.  In fact, they are in a tricky position for several reasons.  First, China is their largest oil customer by far and 20% or more of their oil transits the Strait which means China’s deliveries would slow dramatically and China is one of their only supporters.  Second, the US navy has significant assets in the region and appears quite ready for that move, likely being able to reopen the Strait quickly.  And third, if they follow through and their objective fails (remember, their objective in this would be to spike the oil price and hurt Western economies accordingly) then they will prove conclusively that they are irrelevant militarily.  That is likely not what the regime there wants to demonstrate.

But the market is pretty smart about these things as the collective wisdom and thoughts of traders and investors is an excellent proxy for issues of this nature.  Therefore, we cannot be surprised that after that initial spike in oil prices, they have retreated to Friday’s pre-attack levels as investors await more information.

Source: tradingeconomics.com

It is also worthwhile to recognize that speculative trader positions in oil are net long just under 200K contracts, so there is no short-covering spree that is likely to arrive and drive prices higher.

Source: en.macromicro.me

The point is that if oil is basically unconcerned with the potential issues in Iran, then other markets will completely ignore the situation.  And that is pretty much exactly what we are seeing this morning.  In Asia, equity markets were mixed with modest overall movement.  The Nikkei (-0.15%) and Australia (-0.35%) slid while Hong Kong (+0.7%) and China (+0.3%) rallied showing no trends whatsoever.  The rest of the region did have more laggards than gainers, but other than smaller markets like Indonesia and Taiwan, both falling -1.5% or more, movement was muted.  In Europe, modest losses are the thing with the DAX (-0.4%), CAC (-0.4%) and IBEX (-0.2%) slipping a bit while the FTSE 100 is unchanged on the morning, but there is certainly no panic.  As to US futures, while they opened lower last night, as I type at 6:30 this morning, they are back to flat on the session.

In the bond market, yields have basically edged higher by 2bps across the US, Europe and Japan, either demonstrating that government bonds are no longer a safe haven, or that no haven is necessary because fears of escalation are minimal.  Despite all the negative talk about bonds, I would still opt for the latter explanation.

In the commodity markets, we’ve already discussed oil at length.  In the metals markets, gold is essentially unchanged this morning although we are seeing a mild divergence between silver (+0.6%) and copper (-0.7%), implying to me that there is no underlying risk trend here.

Finally, the dollar is the one thing that is flexing its muscles from a risk perspective as it is pretty sharply higher across the board.  In the G10, NZD (-1.4%) is the laggard followed closely by the yen (-1.25%), which given the weekend’s events is pretty surprising to most folks.  Perhaps yen is not as haven-like as previously thought.  But AUD (-1.1%) is sliding and the euro and pound are both lower by -0.5%.  In the EMG bloc, the dollar is firmer everywhere, but the moves, other than KRW (-1.2%) are less than might have been expected.  HUF (-0.9%) is the next worst performer with PLN (-0.75%) and CZK (-0.75%) all showing their high beta to the euro.  In Asia, CNY (-0.15%) remains dull and INR (-0.2%) is also lackluster.  LATAM currencies are showing little movement as well, with MXN (-0.4%) the laggard of the bunch.

Looking at data this week shows the following:

TodayFlash Manufacturing PMI51.0
 Flash Services PMI52.9
 Existing Home Sales3.96M
TuesdayCase Shiller Home Prices4.2%
 Consumer Confidence99.8
WednesdayNew Home Sales700K
ThursdayInitial Claims247K
 Continuing Claims1947K
 Durable Goods7.2%
 -ex Transport0.1%
 Final Q1 GDP-0.2%
 Goods Trade Balance-$92.0B
FridayPersonal Income0.3%
 Personal Spending0.1%
 PCE0.1% (2.3% y/Y)
 Ex Food & Energy0.1% (2.6% Y/Y)
 Michigan Sentiment60.3

Source: tradingeconomics.com

As well as all this, with most folks looking forward to Friday’s PCE data, we hear from Chairman Powell as he testifies to the Senate on Tuesday and the House on Wednesday.  In addition, there are 13 more Fed speeches from 10 different speakers.  Too, Madame Lagarde regales us three different times.  A cynic might think that central bankers are concerned their comments are losing their importance!

One never knows what is truly happening on the ground in Iran as all news organizations and governments are trying to tell their own story.  However, I do not believe that this is going to escalate into a greater problem going forward, but rather that there is every chance that tensions reduce over time.  I do not believe Iran will even attempt to block the Strait of Hormuz and if this is the worst that the Middle East can produce in the way of war, look for oil prices to slide back toward $65-$70.  As to the dollar, it feels a bit overdone here, so a modest retracement seems viable as well.

Good luck

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Much Hotter

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Remember when riots were seen
Across every TV’s flat screen?
Well, that’s in the past
As news of a blast
In Tehran, just one thing, can mean
 
The Middle East just got much hotter
And now every armchair war plotter
Will offer their views
Of which side will lose
So, traders, keep watch o’er your blotter

 

Is it a coincidence that Israel’s attack on Iran’s nuclear sites occurred on Friday the 13th, or was it meant as a message that luck, both good and bad, can be manufactured? Whatever the driver, the market reaction has been instantaneous.  Here is a look at the five-minute chart in oil with the black sticky stuff jumping more than 8% on the news.

Source: tradingeconomics.com

Too, gold jumped (+1.2%) as did the dollar (EUR -0.4%, AUD -1.0%) although both JPY (+0.3%) and CHF (+0.4%) showed their haven characteristics.  Treasury bonds rallied with yields slipping an additional -3bps in the evening session on top of the -5bp decline during the day, and stock futures are under pressure around the world (S&P500 -1.6%, Nikkei -1.5%, DAX -1.5%).  This was the early price action.

Those were last night’s initial moves and thus far, things have moderated a bit.  For instance, oil has fallen back about 1%, though remains higher by 7.3% and that big gap down on the charts from April has been filled.  

Source: tradingeconomics.com

Of course, there is now a new gap below the markets to fill, but that is a story for another day.  Equity markets are also finding their footing, bouncing off their lows as the 20-day moving average has held and dip buyers see this as an opportunity.  However, the dollar is little changed from its initial moves as is gold, and overall, not surprisingly, risk-off defines the overnight session and likely will be today’s focus.

Now, there is nothing funny about this situation with more death and destruction occurring and likely in our immediate future.  However, I could not help but chuckle at the Russian statement that Israel’s actions were “unprovoked” and “a violation of UN principles and international law.”  Of course, I guess President Putin would know all about unprovoked attacks and violating UN principles and international law given his ongoing efforts in Ukraine.

Ok, I am not a war plotter, nor a war monger, so let’s see how this and any other things are developing in the markets.  While the war discussion will dominate the headlines, there are other things ongoing that are worth considering.  For instance, though the dollar is performing as its historical safe haven this morning, SocGen analysts highlighted a very interesting relationship that has developed in the dollar with respect to inflation surprises over the past four months.  As you can see in the chart below, it appears that as we have seen a series of lower-than-expected inflation readings, the dollar has fallen in step.  Now, correlation is not causality but one could make the case that reduced inflation will lead to a more aggressive easing policy by the Fed and that could be the mechanism by which this relationship operates.

Along the same lines, there have been more stories regarding the softening in the US labor market and at what point the Fed is going to need to focus on that, rather than inflation, as they consider their policy objectives.  As well, the large contingent of analysts who expect the US to enter a recession soon have pointed to the labor market and the fact that much of the underlying data appears to show a less robust situation than the headlines have thus far revealed.  

I have two anecdotes to recount here, neither of which indicates the labor market is softening.  First, the local pizza parlor is at wits’ end trying to hire people to work there, a common high school summer or after school job but there are no takers.  Second, my daughter works for a TMT consulting firm in HR, and they are seeking to hire several new analysts and junior consultants, jobs that pay six figures out of college, and they, too, are having difficulty filling the roles.

I know that anecdata is not definitive, but two very disparate service industries are facing the same issue, and it is not a question as to whether to reduce headcount.  Consider the idea that the recent declines in inflation readings are a short-term outcome and that underlying inflation remains in the 3.5%-4.0% range.  Given median CPI is still running at 3.5%, that is entirely feasible.  If, as we go forward, we start to see high side surprises in inflation, and this relationship has meaning, that could well imply we are looking at a short-term dip in the dollar and that as the year progresses, this will reverse.  My take is that the Fed will only consider cutting rates, at least as long as Powell is Chair, if inflation remains quiescent and unemployment starts to rise.  But if inflation rebounds, I believe they will be reluctant to go there.

Now, as the morning progresses, the dollar is picking up steam with the euro (-0.8%), pound (-.6%) and JPY (-0.6%) all falling, even the havens yen and CHF (-0.5%).  In fact, looking across the board, every major currency is weaker vs. the dollar at this point in the morning (7:15).  As the US has awakened, it seems that the haven status of the dollar is reasserting itself.

Perhaps more surprisingly, Treasury yields have turned around and are now higher by 2bps, which has dragged all European sovereigns along for the ride.  In fact, the weakest nations (Italy +4bps, Spain +5bps) are faring even worse, as is the UK (Gilts +5bps).  Apparently, the recent ideas of the BOE getting more aggressive in its rate cutting is no longer the idea du jour.

In the equity markets, red remains the only color on the screen with Asian markets (Nikkei -0.9%, Hang Seng -0.6%, CSI 300 -0.7%) all rebounding from their early worst levels, but slipping on the day, nonetheless.  I guess there are dip buyers in every market 😃.  In Europe, continental bourses are all sharply lower (DAX -1.4%, CAC -1.1%, IBEX -1.6%) although the FTSE 100 (-0.4%) is holding up better.  As to US futures, they have rebounded slightly from their earliest lows and are now down about -1.0% at 7:20.  Wouldn’t it be something if they closed the day higher?  I don’t think we can rule that out!

Finally, commodities continue to show oil much higher, no retracement there, and gold also holding its gains although copper (-2.5%) is under pressure.  This is a bit odd to me as I would have thought war would bring more copper demand to a market that is physically undersupplied, but then the LME price of copper and the COMEX price of copper seem unrelated to the industrial flows of late.  At this time, everyone is waiting for the Iranian response, although apparently, the first response, a wave of drone attacks on Israel, was completely thwarted.  Not only did Israel destroy some key nuclear sites, but they were able to eliminate almost the entire leadership of the Iranian army and special forces, so any response is likely to take a little time to be created. No oil facilities were targeted, although the Strait of Hormuz is a key chokepoint in the oil market and Iran is likely able to disrupt the flow of tankers through there for now.  What we know is that everyone who was short oil as a trade has likely been stopped out.  It will likely take a little time before new shorts come back to play, so I expect a few days of prices at these levels.  However, the longer-term trend remains lower, so absent a destruction of oil producing fields, I expect that prices will retreat ahead.

On the data front, this morning brings only Michigan Consumer Sentiment (exp 53.5) and with it the inflation expectations piece, although that has been shown to be a political statement, not an economic one.  I cannot shake the feeling that by the time we head to the weekend, equities will have recovered their early losses, and the dollar will cede some of its gains.

Good luck and good weekend

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No Retreating

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The virtue of patience remains
The key to our policy gains
Though tariffs and trade
May one day, soon, fade
It’s still ‘nuff to scramble our brains

 

In a bit of a surprise, Chairman Powell resurrected the term ‘transitory’ in his press conference yesterday with respect to the potential impact on prices from President Trump’s tariff policies.  He explained, “We now have inflation coming in from an exogenous source, but the underlying inflationary picture before that was basically 2½% inflation, 2% growth and 4% unemployment.”  In addition, he said, “It’s still the truth if there’s an inflationary impulse that’s going to go away on its own, it’s not the right policy to tighten policy because by the time you have your effect, you’re in effect, by design, you are lowering economic activity and employment.”  It is this mindset that returned ‘transitory’ to the discussion.  Now, while mainstream economics would agree to that characterization, with the idea being it is a one-off price rise, not the beginning of a trend, given the Fed’s history of using the word to describe the impact of monetary and fiscal policies in the wake of the pandemic, it caught most observers off guard.

But in the end, the Fed’s only policy change was a reduction in the pace of runoff of Treasuries from the Balance Sheet on a temporary basis.  Previously, they had been allowing $25B per month to run off without being replaced and starting April 1, that will be reduced to $5B per month.  The runoff of Mortgage-backed assets will continue as before.  This has been a widely discussed idea as the Fed approaches their target of “ample” reserves on the balance sheet, an amount they still characterize as “abundant”.

As to changes in the dot plot and SEP forecasts, they were, at the margin, modest, with the median dot plot ‘forecast’ continuing to call for 2 rate cuts this year.  Fed fund futures are now pricing in 65bps of cuts, so marginally tighter than the 75bps seen last week.  The SEP also showed slightly different forecasts for growth, inflation and unemployment, but just a tick or two different, hardly enough about which to get excited.  

Certainly, Mr Powell said nothing to upset equity markets as the response was a continuation of the modest rally that began in the morning.  As well, bond yields slid almost 9bps from their level just before the Statement was released.  Net, I expect the only people who are unhappy with the Fed’s performance are the hundreds of millions of Americans who have seen the inflation rate remain above the 2.0% target for the past 48 months (see chart below), but then Powell doesn’t really respond to them directly, now does he?

Source: tradingeconomics.com

Oh yeah, President Trump also published a little note on Truth Social that Powell should cut rates, but I don’t think that had any impact at all.  For now, Trump’s attention is elsewhere, and if 10-year yields continue to slide, I suspect he will be fine, certainly Secretary Bessent will be.

In Europe, the leaders are meeting
Again, as they keep on repeating
They need to spend more
To maintain the war
In Ukraine, ‘cause there’s no retreating

Back in the real world, the diverging points of view between President Trump, and his attempts to end the Ukraine War, and the EU, which seems hell-bent on continuing it ad infinitum were highlighted again today as yet another summit meeting is being held in Brussels to discuss the process and progress on rearming the continent as well as how they envision the future of Ukraine.  This matters to markets as the continuous calls for more fiscal military spending is going to be a driver of equity prices in Europe, and given it is going to be funded by issuing more debt, on both a national and supranational basis, yields are likely to rise as well over time.  

There has been much talk lately of the end of US exceptionalism, and certainly there has been a shift of investment into European shares, especially defense firms, and out of US tech shares.  This has helped support the single currency, which while it has slipped the past two days, remains higher by 4.5% since the beginning of the month.  Ex ante, there is no way to know how this situation will evolve, but if history is a guide at all, the US continues to hold all the defense cards in the deck, and so even with European protests, I suspect the war will come to an end.

But here’s a thought, perhaps even if the war ends, the pre-war energy flows may not resume.  This would not be because Europe doesn’t want cheap Russian gas, but perhaps because Russia doesn’t want to sell it to those who will use it to build armaments that can be used against Russia.  The world has moved to a different place both politically and economically, than where it was pre-Covid.  My sense is many old models may no longer work as proxies for reality, which takes me back to my favorite theme, the one thing on which we can count is more volatility!

Ok, let’s take a turn through markets overnight.  After the US rally, Asia was far more mixed with the Nikkei (-0.25%) slipping a bit and both China (-0.9%) and Hong Kong (-2.2%) falling more substantially on fears that US tariffs could slow growth there more than previously feared.  But elsewhere in the region there were far more gains (Korea, Australia, India, Taiwan) than losses (Malaysia, Thailand). 

Europe, though, is having a tougher session with losses across the board.  The continent is particularly hard hit (Germany -1.7%, France -1.2%, Spain -1.2%) although the UK (-0.3%) is holding up better after decent employment data was released.  We did see the Swiss National Bank cut its base rate by 25bps, as expected, while Sweden’s Riksbank left rates on hold, also as expected.  In fairness, European stocks have had quite a good run, so a pullback should not be a surprise, but it is disappointing, nonetheless.  As to US futures, at this hour (7:10), they are pointing lower by -0.5% or so.

In the bond market, Treasury yields are lower by a further -4bps this morning and down to 4.20%, still well within the recent trading range (see chart below).  As to European sovereigns, they too are lower by between -3bps and -5bps, as despite concerns over potential new issuance, fear seems to be today’s theme.  Oh yeah, JGB yields are still pegged at 1.50%.

Source: tradingeconomics.com

In the commodity bloc, oil is little changed this morning, and net, on the week little changed as well.  It is difficult to see short-term drivers although I continue to believe we will see it drift lower over time as supply continues apace while demand, especially in a slowing growth scenario, is likely to ebb.  Gold (-0.6%) is having its worst day in more than a week, but the trend remains strongly higher.  Arguably a bit of profit taking is visible today.  This is dragging silver (-1.8%) along for the ride although copper (+0.1%) is sitting this move out.

Finally, the dollar is firmer again this morning, higher by 0.5% according to the DXY, with the biggest currency laggards the AUD (-1.1%), SEK (-0.8%) and ZAR (-0.75%).  But the dollar’s strength is universal this morning.  One possibility is that traders have decided Powell is not going to cut rates, hence more pressure on US equities, and more support for the dollar.  I don’t agree with that thesis, as I believe Powell really wants to cut rates, but for now, the other argument has the votes.

On the data front, we get the weekly Initial (exp 224K) and Continuing (1890K) Claims as well as the Philly Fed (8.5) all at 8:30.  Then at 10:00 we see Existing Home Sales (3.95M) and Leading Indicators (-0.2%).  Also, at 8:00 we will get the BOE rate decision, with no change expected.  However, as I have been explaining, central bank stories are just not that important, I believe.  Investors in the UK are far more worried about the Starmer fiscal disaster than the BOE.

There are no Fed speakers on the schedule today, so, I suspect it will be headline bingo.  While the dollar has outperformed for the past two sessions, I continue to believe the trend is lower for the buck and higher for commodities.  Perhaps today is a good day to take advantage of some dollar strength for payables hedgers.

Good luck

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Eclipse

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This morning, the question on lips
Is where did DeepSeek get their chips
As well, there’s concern
That China will learn
Our secrets, and so, us, eclipse

 

Narratives are funny things.  They seemingly evolve from nowhere, with no centralization, but somehow, they quickly become the only thing people discuss.  I’ve always been partial to the below comic as a perfect representation of how narratives evolve for no apparent reason.

Of course, yesterday’s narrative was that the Chinese LLM, DeepSeek, was built by a hedge fund manager with older NVDA chips and for far less money than the other announced models from OpenAI or Google and performed just as well if not better.  While equity traders were not going to wait around to determine if this was true or not, hence the remarkable selling on the open of all things AI, a little time has resulted in some very interesting questions being raised about the veracity of how DeepSeek was built, what type of chips they use and who actually built it.

For instance, a quick look at NVDA’s 10Q shows that, remarkably, Singapore is a major source of revenue, and it has been growing dramatically.

Source: SEC.gov

Now, it is entirely possible that Singapore is a hotbed of AI development, but from what I have read, that is not the case.  In fact, there is basically one lab there that has resources on the order of just $70mm.  But despite that lack of local investment, at least reported local investment, Nvidia shows that chip sales in Singapore nearly quadrupled in the last year.  Far be it from me to suggest that the narrative may change again, but who is buying those chips, more than $17 billion worth?  The idea that they have been trans shipped to China is quite plausible and they may well be what underpins DeepSeek.

Again, I have no first-hand knowledge of the situation but it is not beyond the pale to make the connection that China has been effectively circumventing US export controls through Singapore, have built their own LLM model using the exact same chips as OpenAI and others, but propagated a narrative that they have built something better for much less in order to undermine the US tech sector equity performance and call into question some underlying beliefs in the US market and economy.  Now, maybe this Chinese hedge fund manager did what he said.  But the one thing we know about China is, it is opaque in everything it does, so perhaps we need to take this story and dig deeper.  I am sure others will do so, and more information will be forthcoming, but it highlights that narratives continue to drive markets, but can also, at times, be constructed rather than simply evolve.

The thing is, this is still the only story of note in the market.  Scott Bessent was confirmed as Treasury Secretary yesterday, and indicated he was a fan of gradual tariff increases, perhaps 2.5% per month, rather than large initial tariffs, but that does not seem all that exciting.  And while Trump has not slowed down one iota, his focus has been on things like browbeating California into allowing reconstruction of LA rather than international issues, at least for the past twenty-four hours.  The upshot is that markets, which even yesterday closed far above their worst levels from the opening, are rebounding further today with many of yesterday’s moves reversing, at least to some extent.

Starting in the equity markets, despite the weakness in the tech sector, US market closes were far higher than the opens with the DJIA actually gaining 0.65% on the session.  However, while Japanese shares (-1.4%) definitely felt the pain of the tech sector, the rest of Asia saw some decent performance (Korea +0.85%, India +0.7%, Taiwan +1.0%) although Chinese shares (-0.4%) struggled.  Of course, one reason for that may be that the largest Chinese property company, Vanke, reported humongous losses and both the Chairman and CEO stepped down.

In Europe, though, all is well with every major exchange in the green led by Spain’s IBEX (+1.0%) although gains of 0.5% – 0.7% are the norm.  Now, remember, there is effectively no tech sector in Europe to be negatively impacted by the AI story, and it should be no surprise that these shares have followed the DJIA higher.  And this morning in the US futures market, at this hour (6:50), we are seeing gains on the order of 0.4% across the board.

In the bond market, yesterday’s early rally in prices (decline in yields) backed off as stocks bounced from their lows although Treasury yields still fell 10bps on the day.  This morning, the bounce in yields continues with Treasury yields higher by another 3bps and European sovereign yields rising between 1bp and 2bps on the session.  It will be very interesting to watch the bond market now that Bessent has been confirmed as Treasury Secretary given his goal to extend the maturity of the US debt outstanding.  Arguably, that should push up back-end yields, so we will see how effective he can be in reaching that goal.  

Turning to commodities, yesterday saw a rout there as well with both oil and the metals markets suffering greatly.  However, this morning, like many other markets, things are reversing course.  Oil (+0.75%) has bounced off its lows from yesterday, and despite a pretty rough past two weeks, is still higher than it was at the beginning of the year.  Gold and silver are unchanged from yesterday’s closing levels, and while off their recent highs, remain much higher in the past month.  Copper, too, is bouncing slightly and still much higher this month.  Perhaps yesterday’s price action was a catalyst for lightening up positions rather than changing views.

Finally, the dollar has rebounded vs. the G10 this morning, rising alongside US yields with the euro (-0.7%) and AUD (-0.8%) lagging the field, although dollar gains of 0.5% are the norm across the entire G10 this morning.  In the EMG bloc, the CE4 are all tracking the euro lower, with all down around -0.6% to -0.8%, but yesterday’s biggest laggards, MXN, COP and BRL are little changed this morning, not rebounding, but not falling further.  With the Fed expected to remain on hold while both the BOC tomorrow and ECB on Thursday are set to cut rates, perhaps the FX market is reverting to its more fundamental interest rate drivers than the hysteria of AI models.  If that is the case, then we are likely to turn our attention to Chairman Powell’s press conference as the next critical piece of news.

On the data front this morning, we see Durable Goods (exp 0.8%, 0.4% -ex Transport), Case Shiller Home Prices (+4.3%) and Consumer Confidence (105.6).  Yesterday saw New Home Sales rise more than expected but still resulted in the smallest number of sales for the year since 1995 when the population was far smaller.  

Once again, depending on where you look, you can find data that supports either economic strength or weakness.  It strikes me that today’s data will be of little consequence as traders will be focused on the equity market to see if the rebound has legs, as well as further news regarding DeepSeek.  Tomorrow, however, the Fed will take center stage.

Good luckAdf

A Trump Trope

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For one day the markets expected
That tariffs were roundly rejected
But late yesterday
Trump said the delay
Was short with two nations affected
 
The upshot is all of that hope
That saw the buck slide down a slope
Has largely reversed
As dollar shorts cursed
That tariffs are not a Trump trope

 

This poet feels vindicated in not trying to anticipate what President Trump is going to do that might impact markets after yesterday’s events.  Early in the day there was a story that tariffs would be delayed and were seen as negotiating tools, not punishment.  FX traders (mis)read the room and sold the dollar aggressively, with the greenback suffering declines of more than 1% against some currencies, notably MXN.  Then, Mr Trump was inaugurated, made a speech, where he promised to make many changes within the operating system of the US, signed a load of Executive Orders and mentioned in a press conference much later in the evening that 25% tariffs on Mexico and Canada would be coming on February 1st.  The chart of USDMXN below shows the price action with the peso having given back the bulk of yesterday’s gains.

Source: tradingeconomics.com

Once again, if we learned nothing from Trump’s first term, it is that anticipation of his moves is a very fraught and dangerous way to manage market risk.  Now, will those tariffs actually be implemented?  Will they be universal if they are?  Or does he anticipate changes from behavior by both nations in the next 10 days?  The answer is, nobody knows, probably not even Trump.  The upshot is if you have financial market risk, hedging is critical to maintaining acceptable outcomes.  And, oh by the way, look for implied volatility of all financial products to rise as market makers also have no idea what is going to happen so will require hedgers to pay up for protection.

In Davos, the world’s glitterati
Are meeting, and though they are haughty
They’re losing their splendor
And edicts they render
Are sinking in value like zloty

While there is a great deal more that President Trump has promised to do immediately, the bulk of it seems likely to only have potential longer-term impacts on financial markets.  Meanwhile, in Davos, the World Economic Forum is under way and the main message that I can discern from what I’ve read is that, the members really liked it when everybody listened to what they said and are now really unhappy that President Trump is essentially raining on their parade and devaluing their views and comments.  With Trump withdrawing from the Paris Climate Accords and the WHO, key global initiatives are severely hamstrung, which means the WEF is less important.  And all their pronouncements regarding the need free trade and global cooperation has far less impact if the US has decided to focus on itself rather than the world at large.  My forecast is that by the end of Mr Trump’s term, the WEF will be a sideshow, not a headline event.

And really, at this point, that is pretty much what is happening.  Yes, UK Unemployment rose to 4.4% while wages rose 5.6%, but this has simply put the BOE in a tougher spot.  The Old Lady has only an inflation mandate, but if Unemployment is rising, they cannot ignore that, and the market is now far more convinced (82% probability) that they will be cutting the base rate by 25bps at their meeting the first week of February.  While the pound (-0.8%) is lower this morning, that seems much more about the dollar’s overall strength than this weaker than expected data point as since the release, the pound has fallen only another 0.2%.

So, let’s look around the world and see how markets responded to Trump 2.0.  Equity markets in Asia were largely in the green as neither Japan nor China were mentioned on the immediate tariff list, although the late-night proclamation regarding Canada and Mexico implies that this story has not yet been completed.  Nonetheless, gains in Japan (+0.3%), Hong Kong (+0.9%) and China (+0.1%) showed the way for most of the region with only India (-1.6%) really suffering during the session on a variety of fears regarding tariffs and interest rates despite no mentions by Trump.  In Europe, only Spain’s IBEX (-0.5%) is showing any movement of note and that appears to be specific to some slightly softer than expected corporate earnings results.  Surprisingly, Germany and the rest of the continent are little changed, as is the UK.  As to US futures, at this hour (7:10) they are pointing higher by about 0.4% in anticipation of more earnings reports today and a generally positive attitude from the new president.

In the bond market, Treasury yields have fallen 5bps overnight, seemingly on the idea that because Trump announced the government would do all it can to reduce prices, and therefore inflation, it would magically work.  While I am optimistic things will get better, that is a heavy lift in my opinion and the Fed will need to be far more emphatic on its inflation fighting actions to see this through.  In Europe, yields are basically unchanged across the board and similarly, there was no movement in Asia overnight.  Once again, the world is looking toward the US for directional cues.

In the commodity markets, oil (-1.3%) is sliding back as Trump’s promise to open up more drilling spaces on federal land as well as his overall encouragement of ‘drill, baby, drill’ has traders concerned that supply is going to come around more quickly than demand.  Last January I wrote about my view that there is plenty of oil and it is merely political will that prevents it from being accessed.  I have a feeling that is what we are going to begin to see, a change in that political will which means potentially lower prices and increased demand accordingly.  In the metals markets, gold (+0.5%) is continuing to climb as we approach month end.  There are many in this market who believe the technical picture (see chart below) is pointing to a break to new all-time highs soon.  However another, and perhaps more accurate narrative, is that there is an arbitrage between the NY, London and Shanghai exchanges for physical metal and metal is flowing into NY for delivery which begins next Friday. (H/T Alyosha)

Source: tradingeconomics.com

As to the other metals, they are little changed this morning.

Finally, as mentioned at the top, the dollar is much firmer across the board this morning with the peso and NOK (-1.0%) leading the way lower although most currencies seem to be down by at least -0.5%.  (Yes, PLN is weaker by -0.6%).  This is all dollar-driven with no other idiosyncrasies of note right now.  We shall see how this evolves over time.

On the data front, the rest of the week looks like the following:

WednesdayLeading Indicators0.0%
ThursdayInitial Claims218K
 Continuing Claims1860K
FridayFlash Manufacturing PMI49.6
 Flash Services PMI56.6
 Existing Home Sales4.16M
 Michigan Sentiment73.2

Source: tradingeconomics.com

The Fed is in its quiet period so with the lack of data, I suspect that markets will have heightened awareness to every Trump pronouncement with volatility the new normal.  Remember, consistency is not his strong suit, at least when it comes to commentary about how he may respond to things.

From the market’s perspective, as long as tariffs are still seen as the likely outcome, look for the dollar to remain well bid while equities will see a mixed performance depending on the nature of the company/industry with importers likely suffering.  

Good luck

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Quite Clearly Concerned

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The data on Friday exceeded
All forecasts, and has now impeded
The idea the Fed
When looking ahead
Believes further rate cuts are needed
 
Meanwhile from the Chinese we learned
Their exports are still widely yearned
But imports are falling
As growth there is stalling
And Xi is quite clearly concerned

 

Under the rubric, even a blind squirrel finds an acorn occasionally, my prognostications on Friday morning turned out to be correct as the NFP number was much stronger than expected, the Unemployment Rate fell, and signs of labor market strength were everywhere.  One of the most interesting is the number of quits rose to 13.8%, its highest level in several years and an indication that there is growing confidence amongst the labor force that jobs are available if needed.  As well, as you all are certainly aware, the market responded by selling equities and bonds while reducing the probability of Fed rate cuts this year.  In fact, this morning, the market is pricing in just 24 basis points of cuts for all of 2025, in other words, one cut only.  

Meanwhile, the bond market continues to sell off with yields rising another 2bps this morning.  the chart below shows the dichotomy between Fed funds and 10-year Treasury yields.  Historically, when the Fed was cutting or raising rates, the bond market followed.  But not this time.

Source: tradingeconomics.com

There have been many explanations put forth by analysts as to why this is the case, but to me, the most compelling is that investors disagree with the Fed’s analysis of the economy and, more specifically, with their pollyannaish tone that inflation is going to magically return to 2% because their models say so.  In fact, when looking back over the past 50-years of data, this is the only time that I can see when this dichotomy even existed.

Source: tradingeconomics.com

If I had to guess, there is going to be a lot more volatility coming as previous market signals, and more importantly, Fed market tools, no longer seem to be working as desired.  Nothing has changed my view that 10-year yields head to 5.5%, and if I am correct, look for equity markets to suffer, perhaps quite a bit.

The other story of note overnight was the Chinese trade surplus, which expanded to $104.8 billion in December which took the 2024 surplus to $1.08 trillion.  Now, much of this seems to be preordering of Chinese goods ahead of Trump’s inauguration and the promised tariffs.  But China’s surplus with other Asian economies also grew dramatically last year.  Remember, President Xi is desperate to achieve 5% growth (even on their accounting) and since the Chinese public remains unenthusiastic about spending any money given the $10 trillion hole in their collective savings accounts due to the property market collapse, Xi is reliant on exporting as much as possible.  While this is not making him any friends anywhere else in the world, it is an existential issue for him, so he doesn’t really care.  It will be very interesting to see just how the Trump-Xi relationship moves forward and what concessions are made on either side.

In the end, while the renminbi is basically unchanged this morning, it remains pegged against its 2% limit vs. the CFETS fixing onshore and is 2.35% weaker in the offshore market.  That pressure is going to continue until either the Chinese step up, apply significant stimulus to the domestic economy and start to rebalance the trade process or the PBOC lets the currency go.  Remember, too, Xi is in a tough position because he continuously explained that the renminbi is a good store of value and has been asking his trading partners to use it rather than the dollar.  But if he lets it slide, that will destroy that entire narrative, a real loss of face at the very least, and potentially a much bigger economic problem.  Interesting times.

And so, let us turn to the overnight market activity and see how things are shaping up for today and the rest of the week.  Friday’s sharp decline in US equity indices was followed by similar price action throughout Asia (Nikkei -1.05%, Hang Seng -1.0%, CSI 300 -0.3%, Australia -1.25%) as the narrative is struggling to come up with a positive spin absent further US rate cuts.  European bourses have also come under pressure (DAX -0.7%, CAC -0.8%, IBEX -0.7%, FTSE 100 -0.4%) despite the fact that ECB talking heads continue to explain that more rate cuts are coming, they just won’t be coming quite as quickly as previously expected.  At this point, the market is pricing in 84bps of cuts by the ECB this year.  And yes, US futures are also in the red at this hour (7:00), falling between -0.5% (DJIA) and -1.1% (NASDAQ).

It seems that the narrative writers are struggling to put together a bullish story right now as inflation refuses to fall while growth, at least in Europe, continues to abate.  At least, a bullish story for equities and bonds.  The dollar, on the other hand, has gained many adherents.

Turning to bonds, yields continue to climb across the board with European sovereign yields rising between 2bps (Germany) and 8bps (Greece) and everything in between.  It seems nobody wants to hold bonds right now.  The same was true overnight in Asia where the best performer was the JGB, which was unchanged, but other regional bond markets all saw yields rise between 3bps (Korea) and 9bps (Australia).  Even Chinese yields edged higher by 1bp!

In the commodity space, oil (+2.0%) is en fuego, as the impact of further sanctions on the Russian tanker fleet is being felt worldwide.  It seems the Biden administration has added another 150 Russian tankers to the sanctions list along with insurance companies, and so China and India, who have been the main recipients of Russian oil, are seeking supplies elsewhere.  As long as this continues, it appears oil has further to run.  Meanwhile NatGas (+3.8%) has blasted through $4.00/MMBtu and is now at its highest level since December 2022.  Despite all those global warming fears, the recent arctic blast has increased demand dramatically!

As to the metals markets, the story is different with gold (-0.5%) sliding alongside silver (-2.1%) and copper also trickling lower (-0.15%).  Part of this is clearly the dollar’s strength, which is impressive again today, and part is likely concern over how things are going to play out going forward between the US and China as well as the overall global economy.  Certainly, a case can be made that growth is going to be much slower going forward.

Finally, the dollar is king again, rallying sharply against the euro (-0.5%) and pound (-0.8%) with smaller gains against the rest of the G10 (JPY excepted as it rallied 0.2% on haven flows).  But we are also seeing gains against virtually all EMG currencies (CLP -0.6%, PLN -0.7%, ZAR -0.4%, INR -0.6%) as concerns grow that these other nations will not be able to ably fund their dollar debt as the dollar continues to rise.  FYI, the DXY (+0.35% to 110.07) is at its highest level since October 2022 and looking for all the world like it is going to take out the highs of that autumn at 113.20.

On the data front, this week brings CPI and PPI as well as Retail Sales.  In addition, I was mistaken, and the Fed is not in their quiet period so we will hear a lot more from them this week as well.

TuesdayNFIB Small Biz Optimism100.8
 PPI0.3% (3.4% Y/Y)
 Ex food & energy0.3% (3.7% Y/Y)
WednesdayCPI0.3% (2.8% Y/Y)
 Ex food & energy0.2% (3.3% Y/Y)
 Empire State Manufacturing4.5
 Fed’s Beige Book 
ThursdayInitial Claims214K
 Continuing Claims1870K
 Retail Sales0.5%
 Ex autos0.4%
 Philly Fed-4.0
FridayHousing Starts1.32M
 Building Permits1.46M
 IP0.3%
 Capacity Utilization76.9%

Source: tradingeconomics.com

As well, we hear from five Fed speakers over six venues.  Now, the message from the Fed has been pretty unified lately, that caution and patience are appropriate regarding any further rate cuts but that to a (wo)man they all believe that inflation is heading back down to 2.0%.  I’m not sure why that is the case because if you look at the data, it certainly has the feeling that it has bottomed, and inflation rates are turning higher as you can see from the below chart of core CPI.

Source: tradingeconomics.com

And this is before taking into account that energy prices have been soaring lately!  I realize I’m not smart enough to be an FOMC member, but they certainly seem to be willfully blind on this issue.

At any rate, certainly all things still point to a higher dollar going forward, and I imagine we are going to test some big levels soon enough (parity in the euro, 1.20 in the pound) but I am beginning to get uncomfortable as so many analysts have come around to my view.  Historically, if everybody thinks something is going to happen, typically the opposite occurs.  Remember, markets are perverse!

Good luck

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A Future Quite Noeth

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All eyes will be on NFP
As pundits are hoping to see
A modest result
That can catapult
The market to its apogee
 
If strong, the concern is that growth
Will strengthen and Jay will be loath
To cut rates once more
Which bulls will deplore
Implying a future quite noeth
 
If weak, then the problem for stocks
Is earnings will suffer a pox
So even if rates
Are cut in the States
The NASDAQ may still hit the rocks

 

It’s payroll day and especially after yesterday’s day of respect for the late President Carter closed equity markets in the US, investors are anxious to get back to business.  Here are the latest consensus estimates for the key figures to be released

Nonfarm Payrolls160K
Private Payrolls135K
Manufacturing Payrolls5K
Unemployment Rate4.2%
Average Hourly Earnings0.3% (4.0% Y/Y)
Average Weekly Hours34.3
Participation Rate62.8%
Michigan Sentiment73.8

Source: tradingeconomics.com

As well, there will be annual revisions to the household report today, which is the portion of the process that calculates the Unemployment Rate.  Next month we will see the annual revisions to the NFP, where estimates are already circulating that the number of jobs created in 2024 will be revised down by more than 1 million, nearly one-half of the claimed number (~2.2 million) created.

But ultimately, the reason this data point gets so much press is that it is half of the Fed’s mandate and so is closely watched by the FOMC as they consider any policy stance.  Yesterday, St Louis Fed president Musalem became the seventh or eighth Fed speaker since the last meeting to explain that more caution was warranted as the Fed tries to reduce what they still believe is a modest tightening bias.  “… [rate reductions] have to be gradual – and more gradual than I thought in September,” according to Musalem.  So, caution remains the watchword for every member of the FOMC and accordingly, the market is pricing just a 5% probability of a rate cut later this month.

The thing that has really changed over the past several months is the market’s reaction function to the data.  Part of this is based on the fact that it appears the Fed’s reaction function has changed a bit, and part of this is because the economic situation remains so confusing.

Regarding the Fed, given the fact that the data since they started cutting rates in September has been quite robust and given the fact they no longer have a political/partisan motive to cut rates, it strikes me it will be far harder for Powell and friends to justify further rate cuts from here.  After all, if GDP is growing at 3.0% and inflation is running at 3.3%, absent all other information, that data would truthfully argue for rate hikes.  However, there remains a large camp of analysts that continue to expect a significant slowdown in economic activity, with a number of well-respected voices claiming that we are already in a recession and have been in one since sometime in 2024.  

My view is that this confusion remains best explained by the concept of the K-shaped recovery where a smaller portion of the population, notably those with assets and investments in the markets, have been huge beneficiaries of Fed policies as they not only have seen their portfolios climb in value, but their cash is earning a nice return.  Meanwhile, a much larger percentage of the population, although a group that receives far less press from the financial reporters, continues to struggle given still rising prices and less overall opportunity for advancement.  This is the genesis of the labor strife we have seen, but there are many who remain left behind.  The problem for the Fed is they don’t really see this second cohort as their constituents, at least based on their policy actions.

As to today’s release, if we look at the recent Initial Claims data, it is consistent with a stronger number rather than a weaker one.  However, from a market perspective, I believe that a strong NFP number, something like 200K, will see a risk sell-off as the market continues to remove pricing for any rate cuts in 2025.  This will hurt stocks and likely bonds, although it will help the dollar and, surprisingly, commodities, as the market is likely to see increased demand forthcoming.

Elsewhere, aside from the wildfires in LA, which are a terrible tragedy, the other story in markets today revolves around the ongoing, slow motion disintegration of any remaining credibility in the UK government and its ability to address the many problems there.  Gilt yields continue to rise sharply, although I continue to hear many rationales as to why this is NOT like the October 2022 Gilt crisis.  Alas, while certainly the speed of this decline in Gilts is not quite as dramatic as we saw back then, the duration of the problem is far greater, and we have moved further now than then.  As you can see from the below chart, Gilt yields have risen 110bps since the middle of September, outpacing even Treasury yields and 10yr Gilts now yield 15bps more than Treasuries.  

Source: tradingeconomics.com

In fact, UK 10-year yields are the highest in the G10, although in fairness, they are not yet approaching levels like Mexico (10.6%), Brazil (14.75%) or Turkey (26.4%).  Perhaps Chancellor Reeves has those targets in mind.

OK, let’s see how markets behaved in the lead-up to the data this morning.  There was no joy in Mudville Asia last night as the Nikkei (-1.05%) slid amid new stories that the odds of a BOJ rate hike in two weeks are rising, while Chinese shares (Hang Seng -0.9%, CSI 300 -1.2%) were also under pressure amid news that the PBOC would stop buying bonds (ending QE) and additionally might be selling some to reduce liquidity in Hong Kong as they attempt to slow the decline of the renminbi.  The rest of the region was similarly under pressure across the board. 

In Europe, the picture is more nuanced with the DAX (+0.4%) and CAC +0.3%) showing some modest gains after slightly better than expected French IP data.  However, the FTSE 100 (-0.4%) and other continental bourses (IBEX -0.9%) are not quite as positive, with the FTSE clearly feeling pressure from the overall negative sentiment on the UK, while mixed data elsewhere is undermining any investor sentiment.  US futures at this hour (7:15) are pointing lower by about -0.25% across the board.  Fears of a strong number?

In the bond market, Treasury yields continue to climb, as they are holding onto yesterday’s rise of 5bps and this morning we are seeing European sovereign yields all creep higher by 1bp to 2bps.  JGB yields also rose 2bps overnight as part of that BOJ rate hike story.  In fact, the only market that didn’t see yields rise is China, where they remain within 2bps of their recent all-time lows

In the commodity markets, oil (+3.2%) is skyrocketing as continued cold weather increases heating demand while the reduction in inventories in Cushing, Oklahoma (the main point for NYMEX contract settlements) has raised concern over available supply of crude.  Meanwhile, metals prices continue to climb steadily with gold (+0.3%) continuing its run alongside silver (+0.8%) and copper (+0.45%).  The demand for “stuff” remains strong as nations around the world slowly lose confidence in government bonds as an effective store of value.

Finally, the dollar is, net, little changed this morning with some gains and some losses although few large moves.  On the dollar’s plus side we see KRW (-0.5%), ZAR (-0.55%) and BRL (-0.35%) while the yen and renminbi have both seen modest gains (+0.1%) on the back of the liquidity reduction stories in both nations.  However, we must keep in mind the dollar, as measured by the DXY, remains above 109 and continues to strongly trend higher.  My take is the highs seen in autumn 2022 are the next target, so look for the euro to sink below parity and the pound well below 1.20, probably 1.15, before too long.

There are no Fed speakers on the schedule today, although I imagine we will hear from somebody after the data since they cannot seem to shut up.  However, after today, they head into their quiet period ahead of the next FOMC meeting, so until then we will need to rely on Nick Timiraos from the WSJ to understand what Powell is thinking.

While nothing is that clear, and we could easily see a weak NFP report, my take is we are far more likely to see a strong one with stocks and bonds selling off and the dollar rising further.

Good luck and good weekend

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Falling Further

Posted on by

Like a stone toward earth
The yen keeps falling further
Beware Kato-san

 

While we have not discussed the yen much lately, its recent weakness, in concert with the dollar’s broad strength, has begun to cause some discomfort in Japan.  Last night, Japanese FinMin Katsunobu Kato explained, “We will take appropriate action if there are excessive movements in the currency market.”  He went on that he is “deeply concerned” by the recent weakness, especially moves driven by those evil pesky speculators.

The problem, of course, is that all those expectations that the BOJ would be tightening policy to fight domestic inflation while the Fed would continue to ease policy since they “beat” inflation, with the result being the yen would regain its footing, have proven to be false hope.  Instead, as you can see from the below chart, since the Fed first cut rates back in September, the yen has tumbled nearly 13% and very much looks like it is going to test the previous four-decade highs seen last summer.

Source: tradingeconomics.com

Last year, the MOF/BOJ spent about $100 billion in their efforts to stem the yen’s weakness.  They still have ample FX reserves to continue with that process, but ultimately, history has shown that maintaining a cap on a currency that is weakening for fundamental reasons is nigh on impossible.  If a weak yen is truly seen as existential in Tokyo, then Ueda-san needs to be far more aggressive in tightening monetary policy.  This is especially so given the Fed continues to back away from earlier expectations that it would be aggressively loosening policy.  Now, while JGB yields have moved higher over the past several sessions, trading now at 1.18%, which is their highest level since April 2011, that is not going to be enough to stem this tide.  From what I read, inflation is an issue, but not the same as it was in the US in 2022, so Ueda-san is not getting the same pressure to address it as Powell did back then.  My read is the BOJ remains on hold this month and hikes rates in March while the yen continues its decline.  Look for another bout of intervention when we test the 162 level, but that will not stop the rot.  Nothing has changed my view of 170 or higher in USDJPY by year end.

Though Treasury yields have been rising
Most credit spreads have been downsizing
So, corporate supply
Is ever so high
An outcome that’s somewhat surprising

In the bond market, government bond yields continue to rise around the world (China excepted) as investors increase their demands in order to hold the never-ending supply of new bonds.  Ironically, despite this ongoing rout in government bonds across the board, corporate debt issuance looks as though it will set new records this month.  One thing to remember here is that corporates have a lot of debt coming due over the next two years as all that issuance during the ZIRP period needs to be rolled over.  But the other thing to recognize is that corporate credit spreads, the amount of yield investors require to own risky corporate bonds vis-à-vis “safe” government bonds, has fallen to its lowest levels in years, and as can be seen in the chart below, the extra yield available for high-yield investors is shrinking faster than for investment grades.

Potentially, one reason for this is the dramatic increase in the amount of Private Credit, the latest investment fad where weaker credits go directly to funds designed to lend money rather than to their banks, and investors ostensibly remove one of the middlemen from the process.  As such, there is less of this debt around than there otherwise might be, hence increasing demand and reducing that credit spread.  But the other reason is that there continues to be a significant amount of investable assets looking for a home, and with global yields near the highest they have been in a decade or more, and with the equity market dividend yield down to just 1.27% or so, a record low, there are lots of investors who are comfortable with clipping 5% or 5.5% coupons on BBB corporate bonds.

The question I would ask is, if government bond yields continue to climb, and I see no reason for that to stop given the trend in inflation and necessary issuance, at what point are investors going to get scared?  We are likely still a long way from that point, but beware if the new Treasury Secretary, Scott Bessent, follows through with his hinted views of reducing T-bill issuance and increasing coupon issuance, yields could go much higher absent the Fed implementing QE.  That would cause some serious market ructions!

Ok, let’s see how things look around markets this morning after yesterday’s sell-off in the US equity markets.  It seems Japanese stocks were caught between the weaker yen (generally a stock positive) and the tech sell-off (generally a stock negative) with the Nikkei closing lower by -0.25% on the session.  Meanwhile, the Hang Seng (-0.9%) suffered a bit more on the tech move, although Mainland shares (-0.2%) were not as badly affected.  An interesting story here is that the chief economist at state-owned SDIC Securities made comments at an international forum run by the Peterson Institute that really pissed off President Xi.  Gao Shanwen said the quiet part out loud when he claimed that actual GDP growth in China for the past several years has likely been much closer to 2% than the 5% published.  That story has been widespread in the West, although has never been given official credence.  And for Xi, 2% growth is not going to get it done, what with the property bubble still imploding and consumption declining despite promises of more stimulus.  Stay tuned to this story to see if we start to see more Western analysts reduce their expectations.  Elsewhere in Asia, the picture was mixed with gainers (Korea, Australia, Singapore) and laggards (Taiwan, Malaysia, Philippines).

In Europe, red is today’s color, led by the CAC (-1.0%) although we are seeing losses across the board. Eurozone data showed declining Consumer Confidence, Economic Sentiment and Industrial Sentiment all while inflation expectations remain stubbornly high.  That stagflationary hint is typically not an equity market benefit so these declines should be expected.  The story on the continent is not a positive one and I maintain that the ECB is going to have to cut rates more aggressively than their inflation mandate would suggest.  That might support equities a bit, but it will be hell on the euro!  Finally, US futures are a touch softer (-0.2%) at this hour (7:05) although they were higher most of the overnight session before this.

As mentioned above, bond yields are higher with Gilts (+9bps) leading the way as not only is the economy suffering from some very poor policy decisions by the Starmer government, but it seems that the ongoing political crisis regarding grooming gangs has investors shying away.  But yields continue to rise across the board with continental yields up between 3bps and 6bps, Treasury yields higher by another 1bp this morning after a 10bp rise in the previous two sessions, and JGB yields, as mentioned, higher by 5bps.  This trend is very clear!

In the commodity markets, oil (+0.5%) keeps on keeping on, as API data showed a greater than 4mm barrel draw on inventories, far more than expected and indicating a reduced supply around.  Cold temperatures are keeping NatGas (+5.0%) firm as well.  In the metals markets, both precious and base are under a touch of pressure this morning, down less than -0.2%, largely in response to the dollar’s rebound.

Speaking of the dollar, it is higher against all its counterparts this morning with the pound (-1.2%) the G10 laggard although weakness on the order of 0.5% is pretty common this morning.  In the EMG bloc, ZAR (-1.5%) is the worst performer, after weaker than expected PMI data called into question the economic path forward.  But here, too, we are seeing weakness like MXN (-0.9%), CLP (-0.8%), PLN (-0.8%) and KRW (-0.5%).  I would be remiss to ignore CNY (-0.25%), which is trading below (dollar above) 7.3600 in the offshore market, and is now 2.4% weaker than last night’s fixing rate.  This is also the weakest the renminbi has been since it touched this level back in September and then November 2007 prior to that.  Those Chinese problems are coming home to roost for President Xi.

On the data front, ADP Employment (exp 140K) leads the day followed by Initial (218K) and Continuing (1870K) Claims.  These are being released this morning because of tomorrow’s quasi holiday regarding the late President Carter, when US markets will be closed.  This afternoon, the FOMC Minutes arrive and will be scrutinized closely to see just how hawkish they have become.  We also hear from Governor Waller this morning with caution being the watchword from virtually every Fed speaker of late.

It is all playing out like I anticipated, with the ISM data showing strength yesterday, not just in the headline number, but also in the Prices Paid number.  The Fed will have no chance to cut rates again, and I look for the dollar to continue to rise.

Good luck

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Havoc the Dollar Will Wreak

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Apparently, President Xi
Is starting to listen to me 🤣
His currency’s falling
As he stops forestalling
The weakness in his renminbi
 
But it’s not just yuan that is weak
The havoc the dollar will wreak
Is set to keep growing
As funds keep on flowing
To US investments, still chic

 

It seems that one of President Xi Jinping’s New Year’s resolutions was to finally allow the renminbi to resume its longer-term decline.  While 7.30 has been the line in the sand for a while, as can be seen from the first chart below, suddenly, as the calendar page turned to 2025, it appears that the PBOC is going to allow for the renminbi to weaken further.  Thus far, the PBOC has been adamant about fixing the Chinese currency at levels much stronger than anyone wants to pay for it, and even last night that was the case, with a fixing rate of 7.1878.  However, while the onshore market must trade within +/- 2% of that fixing rate, no such restriction limits the offshore market, and this morning, the offshore renminbi is trading 2.3% weaker than the fixing, above 7.35 to the dollar.

Much has been made of the “chess” moves that are ongoing between the US and China regarding currency policy with many pundits blankly claiming that if Trump is to impose the threatened tariffs, the renminbi will simply weaken to offset them.  However, while I do believe the CNY has much further to fall, that is not the driving case I see.  Rather, Xi’s problem is that his economy is not in nearly as good condition as he needs it to be and confidence in the consumer sector continues to wane.  This is largely a result of the ongoing destruction of the property bubble that was blown for decades.

Remember, Chinese investors have tied up significant personal wealth in second and third homes as stores of value.  This was encouraged as cities could sell property to developers, get paid a bunch to help finance their operations, and since demand was so high, prices kept rising so everyone was happy.  Alas, as with all bubbles (I’m looking at you, too, NASDAQ) eventually the air comes out.  For the past three years the Chinese have been trying to deal with this collapsing property market, but house prices continue to decline thus reducing investor wealth and confidence.  I read that there are an estimated 80 million empty homes that have been built over the past decades and are now in disrepair in the countryside.  These are the ghost cities that were all part of the Chinese growth miracle, but in fact were simply massive malinvestment.

While the prescription for China has long been to increase its consumer sector of the economy, Xi and his minions at the central committee have no idea how to do that (given they are communist, this is not that surprising) and so continue to support the means of production.  The problem is they have now seemingly gone too far in that space as well with not merely the Western world, but also much of the developing world starting to push back on all the excess stuff that is coming from China.  

Xi’s other problem is that as he rails against the dollar and seeks others to use the renminbi in their trade, if the currency starts to fall sharply, that will be a difficult ask.  Given the US FX policy remains benign neglect, it is entirely upon China to solve their own problems.  While it is unlikely to happen in a big devaluation a la August 2015, weakness is the trend to bet here this year.

Source: tradingeconomics.com

Source: tradingeconomics.com

Away from that news, though, the year is starting off in a fairly modestly.  Most of the world’s focus is on the upcoming Trump inauguration as well as the political machinations that will begin today as Trump’s Cabinet nominees start to go through their paces in front of the Senate.  New Year’s Eve’s horrifying terrorist attack in New Orleans has just upped the ante with respect to Trump getting his picks through the process.  

So, let’s review the overnight market activity to get a sense of what today could bring.  The first day of the US trading year resulted in modest declines across the board in equities, although as I type (7:30), they appear to be retracing those losses and are slightly higher.  The bigger news was from Asia where both the Nikkei (-1.0%) and CSI 300 (-1.2%) showed weakness with the former feeling the pain of some profit taking after gains last week, although Chinese shares seem to be succumbing to the troubles I have described above.  Elsewhere in the region there was no consistency with gainers (Hong Kong, Taiwan, Korea and Australia) and losers (India, New Zealand, Malaysia) with other exchanges little changed.  In Europe this morning, there is more red than green with the CAC (-0.8%) the biggest laggard amid concerns over the fiscal situation in France.  But the DAX (-0.35%) and FTSE MIB (-0.45%) are also lagging with only Spain’s IBEX (0.0%) bucking the trend.

In the bond market, Treasury yields have slipped 2bps this morning, but remain above 4.50%, something that continues to vex Chairman Powell as he and the Fed seemed certain that by cutting the Fed funds rate, he would drive the entire yield curve lower.  I wonder if he will learn this lesson about the relation between a made-up rate (Fed funds) and market rates (bond yields) anytime soon.  In Europe, French yields are 2bps higher, widening their spread vs. German bunds and perhaps more remarkably, at least from a nominal perspective, well above Greek government bond yields now! (Remember, there are far fewer GGB’s around than OAT’s so there is a scarcity bid there). Certainly, Madame Lagarde must be getting a bit concerned over her native nation’s profligacy and I suspect that the fiscal ‘need’ for lower Eurozone interest rates is one of the features of the discussion regarding the ECB’s future path (lower).  As to JGB’s, they are unchanged, sitting at 1.07% and showing no sign of rising anytime soon.  One last thing, Chinese 10yr bonds now yield a new record low of 1.61%, 2bps lower on the day and pretty convincing evidence that not all is well in the Middle Kingdom’s economy.

On the commodity front, oil (-0.2%) is consolidating yesterday’s strong gains which were ostensibly based on the idea that President Xi will successfully implement more stimulus and aid growth in China.  History shows otherwise, but we shall see.  Gold (-0.1%) is also consolidating yesterday’s strong gains as it appears there has been renewed central bank buying activity to start the year.  The other metals also benefitted yesterday with silver (+0.8%) continuing this morning.

Finally, the dollar is retracing some of yesterday’s gains but remains much stronger than we saw just last week, and certainly since the last time I wrote.  Looking at the Dollar Index, it is hovering near 109 this morning, having traded well above that yesterday afternoon.  The next obvious technical target is 112, about 3% higher and there are now many calls for a test of the 2002 highs of 120.  I assure you, if the DXY gets to those levels, EMG currencies are going to come under a great deal of pressure.  As an example, we already see several EMG currencies (CLP, BRL) trading at or near all-time lows (dollar highs) and there is nothing to think this will change soon.  As well, check out the euro at 1.03 this morning, which while 0.3% higher on the session, appears as though it could well test those October 2022 lows (dollar highs) sooner rather than later, especially if the ECB continues to lean more dovish than the Fed.  If you are a receivables hedger, currency puts seem like a pretty good idea these days.

On the data front, ISM Manufacturing (exp 48.4) and Prices Paid (51.7) are all we have today and late this morning Richmond Fed president Barkin speaks.  Interestingly, tomorrow evening and Sunday we hear from SF Fed President Daly and tomorrow evening Governor Kugler will be joining Daly.  I guess they can’t go but so long without hearing their voices in the echo chamber!

There is nothing to suggest that the dollar, while modestly softer today, is set to turn around soon.  Keep that in mind.

Good luck and good weekend

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