Tag Archives: #higherdollar

The Doves Will Be Shot

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Inflation was just a touch hot

And certainly more than Jay sought

So, later today

What will the Fed say?

My sense is the doves will be shot



Instead, as Jay’s made manifest

Inflation is quite a tough test

So, higher for longer

Or language much stronger

Is like what he’ll say when he’s pressed






Let’s think a little outside of the box this morning, at least from the perspective of virtually every pundit and their beliefs about what will happen at the FOMC meeting today.  At this point, most of the punditry seems to believe that Powell cannot be very much more hawkish, especially since the market is expecting comments like inflation is still too high and the Fed will achieve their goal.  So, there is a growing camp that thinks any surprise can only be dovish, since if he doesn’t push back hard enough or talk about loosening financial conditions being a concern, the equity market response will be BUY STONKS!!!





But what if, the thing Powell really wants, or perhaps more accurately needs, is not a soft landing, but a full-blown recession!  Think about it.  As I have written repeatedly, the idea that the Fed will cut rates by 125bps next year because growth is at 1.5% or 2.0% and inflation has slipped to 2.5% seems like quite an overreaction.  But given the current US debt situation ($34 trillion and counting) and the fact that the cost of carrying that debt is rising all the time, what would get the Fed to really cut rates?  And the only thing that can do it is a full-blown, multiple quarters of negative GDP growth, rising Unemployment Rate, recession.  If come February or March, we start seeing negative NFP numbers, and further layoff announcements as well as declining Retail Sales and production data, that would get the Fed to act. 





At least initially, we would likely see inflation slide as well, and with that trend plus definitive weakness in the economy, it would open the door for some real interest rate cuts, 400bps in 100bp increments if necessary. Now, wouldn’t that take a huge amount of pressure off Treasury with respect to their refi costs?  And wouldn’t that encourage accounts all over the world to buy Treasuries so there would be no supply issues?  All I’m saying is that we cannot rule out that Powell’s master plan to cut rates is to drive the economy into a ditch as quickly as possible so he can get to it.  In fact, it would open the door to restart QE as well.





This is not to say that this is what is going to happen, just that it is not impossible, and I would contend is not on anyone’s bingo card.  Now, Powell will never say this out loud, but it doesn’t mean it is not the driving force of his actions.  Powell is incredibly concerned with his legacy, and he has made abundantly clear that he will not allow his legacy to be the second coming of Arthur Burns.  Instead, he has his sights on the second coming of Paul Volcker, the man who killed the 1970s inflation dragon.  St Jerome Powell, inflation slayer, is what he wants as his epitaph.  And causing a recession to kill inflation and then cut rates is a very clever, non-consensus solution.





How will we be able to tell if I’m completely nuts or if there is a hint of truth to this?  It will all depend on just how hard he pushes back on the current narrative.  Yesterday’s CPI results could best be described as ‘sticky’, not rebounding but certainly not declining further.  Shelter costs continue apace at nearly 6% Y/Y and have done so for more than 2 years.  I was amused this morning by a chart on Twitter (I refuse to call it X) that showed CPI less shelter rose at just 1.4% with the implication that the Fed needs to start cutting rates right away.  The problem with that mindset is that shelter is something we all pay, and there is scant evidence that housing markets are collapsing.  In fact, according to the Case Shiller index, they are rising again.  I would contend that there is plenty of evidence to which Powell can point that makes his case for an economy that is still running far too hot to allow inflation to slide back to their target.  And that’s what I expect to hear this afternoon.





Speaking of recession, let us consider the situation in China, where despite the CCP’s annual work conference just concluding with some talk of building a “modern industrial system” the number one goal this year, thus boosting domestic demand, they announced exactly zero stimulus measures to help the process.  Data from China overnight showed that their monthly financing numbers were all quite disappointing compared to expectations and the upshot was a further decline in Chinese and Hong Kong equity markets.  This ongoing economic weakness and the lack of Xi’s ability or willingness to address it continues to speak to my thesis that commodity prices will remain on the back foot.  If you combine the high interest rate structure in the G10 with a weaker Chinese economy, the direction of travel for energy and base metals is likely to be lower.  The one exception here is Uranium, where there is an absolute shortage of available stocks and a renewed commitment around the world to build more nuclear power plants.





At the same time, Europe remains pretty sick as well, with Germany leading the entire continent into recession, and likely dragging the UK with it.  Germany, France, Norway, the UK and others are all sliding into negative growth outcomes.  While Chairman Powell will continue to push back on the idea of rate cuts soon, I expect that tomorrow, when both the ECB and BOE meet, they will open the door to rate cuts early next year.  Inflation in both places has been falling sharply and there is no evidence that Madame Lagarde or Governor Bailey is seeking to be the next Paul Volcker.  Both will blink with the result that both the euro and the pound should feel pressure.





Summing it all up, today I think we get maximum hawkishness from the Fed with Powell pushing back hard on the market pricing.  Initially, at least, I expect we could see yields rise a bit and stocks sell off while the dollar continues its overnight rise.  But I also know that there are far too many people invested in the idea that the Fed must cut soon, and they will be back shortly, buying that dip until they are definitively proven wrong.  





As to the rest of the overnight session, aside from China’s weak performance, South Korea also lagged, but the rest of the APAC region saw modest gains.  Europe, meanwhile, is all green, although it is a very pale green with gains on the order of 0.2%, so no great shakes.  Finally, US futures are firmer by 0.1% at this hour (7:15) after yesterday’s decent gains.





Bond yields are sliding this morning, down 2bps in the US and falling further in Europe with declines of between -3bps and -6bps on the continent as investors and traders there start to price in a more aggressive downward path for interest rates by the ECB.  UK yields are really soft, -9bps, after GDP data this morning was disappointing across the board, especially the manufacturing data.





Oil prices (+0.45%) which got slaughtered yesterday, falling nearly 4%, are stabilizing this morning, as are gold prices, which fell yesterday, but not quite as much as oil.  However, the base metals complex continues to feel the pressure of weak Chinese demand.  I continue to believe that there are structural supply issues, but right now, the macro view of weak economic activity is the main driver, and it is driving prices lower.





Finally, the dollar is firmer this morning as weakness elsewhere in the world leaves fewer choices for where to park funds.  While the movement has not been overly large, it is quite uniform across both G10 and EMG currencies.  The laggards have been NZD (-0.6%) after a softer than expected CPI reading and ZAR (-0.6%) on the back of weakening metals prices.  If I am correct about the path going forward, the dollar should perform well right up until the Fed responds to much weaker economic activity and starts to cut rates aggressively.  At that point, we can see a much sharper decline in the greenback.





Ahead of the FOMC meeting, this morning we get November PPI (exp 1.0%, 2.2% core) which would represent a small decline from last month’s data.  We will also see the EIA oil inventory data, which has shown a recent history of builds helping to drive the oversupply narrative there.





At this point, it is all up to Jay.  I suspect that markets will be quiet until then, and it will all depend on the statement, the dot plot and the presser.





Good luck





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			News Not to Like
		


				

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Before we all hear from Chair Jay
This morning we’ll see QRA
The question is will
The bond market kill
The vibe all things are okay

While no one expects a rate hike
Of late, there’s been news not to like
Both housing and wages
Have moved up in stages
Though as yet, there’s not been a spike






We are definitely in a period where there is a huge amount of new information to digest on a daily basis, whether it is data or policy actions by central banks and finance ministries.  During times like this, we have historically seen slightly less liquidity in markets as the big market-makers reduce their activity to prevent major blowups.  Of course, the result is that we have periods that are quite punctuated by sharp moves on the back of the latest soundbite.





So, with that in mind, let’s look at today’s stories.  Starting last night, we saw JGB yields rise to yet another new high for the move, touching 0.98%, before the BOJ executed an unscheduled bond-buying exercise to push back a bit.  Ultimately, the 10-year JGB closed back at 0.94%, but despite the brave words from Ueda-san yesterday, it is clear there will be no collapse in the JGB market.  They simply will not allow anything like that to happen.  At the same time, USDJPY retraced about 0.3% of its recent decline, but continues to hold above 151 for now.  We did hear from Kanda-san, the new Mr Yen, that they were watching carefully, but given the rise in JGB yields has been matched by the rise in Treasury yields, it is hard to get too bullish, yet, on the yen.  





This is the first big assumption that has not played out as anticipated.  Prior to the BOJ meeting, the working assumption was that when they adjusted YCC the yen would start to rally sharply.  My view has always been that the yen won’t rally sharply until the Fed changes their tune, and that is not yet in the cards.  If the BOJ intervenes, it is probably a good opportunity to sell at those firmer yen levels as until policies change, a weaker yen remains the most likely outcome.





Turning to the US, at 8:30 this morning the Treasury is due to announce the makeup of the $776 billion of debt they will be borrowing this quarter.  The key issue is how much will be short-dated T-bills and how much will be pushed out the curve.  The higher the percentage of long-dated issuance, the more pressure we will see on the bond market going forward.  The 10-year yield is already back to 4.90% this morning, rising another 3bps, and we are seeing pressure throughout Europe as well with yields there up between 1bp and 3bps except for Italian BTPs which have seen yields rise 9bps this morning.  That has taken the Bund-BTP spread back to 200bps, the place where the ECB starts to get concerned.





But back to the US, where a second key narrative assumption has been that housing prices would be falling, thus reducing pressure on the inflation metrics over time.  Alas, that assumption, too, has been called into question after yesterday’s Case Shiller home price data showed a rise in home prices across the country, back toward the peak seen in June 2022.  While the number of transactions continues to decline, given the reduction in both supply and demand it seems that it is still a sellers’ market.  If housing prices don’t decline, then it seems even more unlikely that rents will decline and that means that inflation is going to remain much stickier than the Fed would like to see.  This does not accord well with the thesis that a slowing economy is going to help bring down housing demand followed by slowing inflation.  





As well, there was another data point yesterday, the Employment Cost Index, which rose a more than expected 1.1% Q/Q, and looking at the chart of its recent movement, shows little inclination that it is heading lower.  This is a key data point for the Fed as rising wages is something of which they are greatly afraid given the belief in its impact on prices.  While the White House may have celebrated the UAW’s ability to extract significant gains from the big three automakers, I’m guessing the Fed was a bit more circumspect on the effects those wage gains will have on overall wages in the economy and inflation accordingly.  





Adding all this up tells me that the ongoing belief that inflation is going to be declining steadily going forward, thus allowing the Fed to reduce the Fed funds rate and achieve the highly sought soft-landing is in for a rude awakening.  Rather, I remain quite concerned that monetary policy is going to remain much tighter for much longer than the market bulls believe.  And that means that I remain quite concerned equity multiples will derate lower along with equity markets overall.





Turning to the overnight price action, after a late rebound in the US taking all three major indices higher on the day, though just by 0.3% or so, we saw a big boost in Tokyo, with the Nikkei jumping 2.4%, as it seems there is joy in the idea that the BOJ may allow yields to rise further.  Either that or they were happy to see the BOJ buy bonds, I can’t tell which!  Europe, though, is a touch softer this morning with very marginal declines and US futures markets are looking to reverse yesterday’s gains, all -0.35% or so, at this hour (8:00).





Oil prices are higher this morning, up 1.8% as concerns about escalation in the Middle East seem to be growing after some comments about a wider war and further attacks by both Iranian and Hamas leaders.  Gold is little changed today but did suffer in yesterday’s month end activity although copper is firmer this morning in something of a surprise given the continuing weak PMI data we have been seeing.





Finally, the dollar continues to flex its muscles as the DXY is back just below 107 with both the euro and pound lower this morning by about -0.25%, and virtually all EEMEA currencies under pressure as well.  Other than the yen’s modest rebound, the dollar is higher vs. just about everything.





On the data front, in addition to the QRA and the FOMC later this afternoon, we see ISM Manufacturing (exp 49.0), Construction Spending (0.5%) and JOLTS Job Openings (9.25M).  Overnight we saw weaker PMI data from Japan (48.7) and China (Caixin 49.5), although for some reason, European PMI data is not released until tomorrow.





At this point, it is very much a wait and see session but as far as I can tell, the big picture has not yet changed.  Inflation remains stickier than the Fed wants, and the market seems to believe which leads me to believe we are going to see yields remain higher for quite a while yet.  I would estimate we will see 5.5% 10-year yields before we see 4.5% yields and if that is the direction of travel, equity markets are going to have a tough time while the dollar maintains its bid.





Good luck





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			A Rough Week
		


				

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Investors have had a rough week
As both stocks and bonds sprung a leak
The hope is, today
The data will say
Inflation is well past its peak

The thing is, Q3’s GDP
Described a robust ‘conomy
Will that push the Fed
When looking ahead
To restart their tightening spree?






I imagine most of us are a little tired of the negativity in markets on a daily basis of late.  Yesterday was just another in a series of negative equity market sessions with the US indices declining between -0.75% (DJIA) and -1.75% (NASDAQ).  And this happened despite (because of?) a significantly higher GDP report than most analysts had forecast.  The print, 4.9%, was truly impressive and it was accompanied by stronger than expected Durable Goods orders (4.7%) and continuing solid Initial Claims data (210K).  In other words, the data points to a robust US economy which, one might conclude, would be a positive for risk assets.  One would be wrong.





It seems there are many possible explanations for this seeming conundrum although I favor the following: ongoing elevated interest rates are putting pressure on earnings multiples and driving them lower.  The fact that GDP growth remains robust implies the Fed will be in no hurry to cut rates thus maintaining its higher for longer attitude for even longer.  In this situation, the discount cash flow model, which underlies much, if not most, stock market analysis, tells us that companies growing at 10% cannot be valued at 50x earnings, the math just doesn’t work.  Hence, despite solid performance, investors are rerating the value of these companies lower.  The bigger problem is that the current market multiple remains well above its long-term average so there is further, potentially, to fall.





One other thing to note regarding the economy is that it is quite common for there to be very strong quarterly GDP prints just before a recession begins.  Clearly yesterday’s number was quite strong, in fact the strongest (excluding the post-covid rebound) since Q1 2014.  However, that does not preclude the fact that we may still be headed toward a recession.  Now, arguably, a recession, or at least if the data starts to look like a recession is upon us, would get the Fed to change their tune and consider relaxing their current policy stance.  However, recessions tend to come with much lower earnings and historically are not that good for risk assets either.  It is this concern that has so many praying calling for a soft landing.  Alas, I would not wager on that outcome.





I think it is important to remember that market movements do not have to be driven by outside catalysts but can happen of their own volition.  In fact, that is my point on the rerating of market multiples.  This can occur regardless of any data, whether good or bad.  If the investor community is becoming nervous, and if there is an alternative like we have today with short-dated Treasuries yielding 5% or more, equity prices can decline much further around the world, whatever their current valuations are.  While we all try to rationalize movements in the markets after the fact, on any given day, no specific catalyst is needed from outside the market itself.





With this in mind, though, the rest of the world has not followed yesterday’s US market lead and instead we have seen a rebound in Asian shares with the Hang Seng (+2.1%) leading the way but the rest of the space mostly higher by at least 1%.  European bourses are more mixed with a combination of mostly small gains and losses although the CAC in Paris is an outlier (-1.0%).  US futures, though, are mostly in the green with the NASDAQ the leader (+0.6%) at this hour (7:45).





The bond story, though, is quite interesting as there has been a great deal of volatility in this space of late.  You may recall that I mentioned the abysmal 5-yr auction on Wednesday.  Well, yesterday the Treasury auctioned 7-year paper and the results were outstanding with the best bid-to-cover ratio since March 2020.  This led to a major rally in the bond market with yields continuing their yoyo movement and falling 14bps although this morning they are bouncing from those levels and are higher by 3bps.  European sovereigns did not come along for the Treasury ride yesterday showing much less movement and this morning they are edging lower by between 1bp and 3bps. This is in the wake of yesterday’s ECB meeting where Madame Lagarde left policy on hold for the first time after eleven consecutive rate hikes, and tried to explain that they would be completely data dependent for the time being.  Not for nothing but the recent data from Europe looks pretty awful, so if that is the case, I would expect to see cuts on the horizon there.





Volatility continues apace in the oil market as well with yesterday’s decline followed by 1.5% rally this morning.  It seems that yesterday’s story about a potential de-escalation of the Israeli-Palestinian crisis was trumped by news that the US had bombed several sites in Syria in response to attacks on US bases in Iraq last week.  Ostensibly these sites are controlled by Iranian proxies indicating the possibility of a widening conflict in the Middle East.  I suspect that we are going to continue to see volatility here, but net, the structural issues remain beneficial for oil in my view.  As to gold, it is little changed this morning and simply maintaining its recent gains as fear continues to be a market driver right now.  Base metals were clearly cheered by the strong US data as both copper (+1.1%) and aluminum (+0.25%) are firmer this morning.





Looking at the dollar, it should be no surprise that it continues to perform well overall.  Between the risk issues and the strong economic data, the US certainly seems a better place to put your money than most others right now.  USDJPY continues to trade above 150 but is not running away and there is no indication the BOJ has been involved at all.  The euro keeps pushing toward 1.05 and the pound looks like it is headed down to 1.20 soon.  USDCNY is back near its recent highs as the perceived benefits of Chinese fiscal stimulus are not seen as yuan positives at this point, especially given the divergence between US and Chinese monetary policy.  It is very difficult, at this time, to come up with a reason for the dollar to decline in any substantial way.





On the data front, this morning brings Personal Income, (exp 0.4%), Personal Spending (0.5%), and the all-important Core PCE (0.3%, 3.7% Y/Y) with Michigan Sentiment (63.0) coming later at 10:00.  At this point, all eyes remain on the FOMC meeting next week where there is essentially no expectation of a rate move.  We would need to see a REALLY hot PCE number this morning to change that.  As such, I expect that a consolidation in risk markets is quite possible with little movement in the dollar overall.  Beware, however, if stocks sell off later today as that could be a tell that there is more pressure to come.  I clearly recall that the Friday before Black Monday in October 1987, stocks sold off aggressively, just not as aggressively as they did on the Monday!.





Good luck and good weekend





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			Many More Pains
		


				

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Reporting of real GDP
Is what most investors will see
But nominal data
Is what could create a
New narrative reality

Combining both growth and inflation
This number could be the foundation
For further yield gains
And many more pains
Inflicted on stock adoration






After another lousy day in the equity markets, today the first Q3 GDP data will be released.  The current consensus forecast is for a 4.3% gain while the Atlanta Fed’s GDPNow number is up to 5.4%.  And that’s the real GDP (rGDP) number, which removes inflation from the discussion.  However, given all that is ongoing, it may be worthwhile to take a look at nominal GDP (nGDP), which is simply the change in total activity including price changes and economic output.  As you can see from the below graph (data source, FRED database), in the post-WWII era, we’ve had 10 periods where rGDP fell below zero, better known as recessions, but only 3 periods where nGDP was negative, with the GFC in 2009 being the worst at -2.0%.  The gap between the two lines is inflation, and you can also see how that has ebbed and flowed over time.










But turning to the current period, it is noteworthy that in the wake of the GFC, which was rightly called the worst financial crisis since the Great Depression and up through the Covid recession in 2020, nGDP had been pretty modest overall.  In fact, a quick look at the data shows that the average nGDP during that decade was just 3.4%.  This compares quite unfavorably with the long-term historical average of 6.4% since 1946.  Looking at rGDP data, the average between the GFC and Covid was just 1.8%, again comparing quite unfavorably to the long-term growth of 2.9%.





The thing is, we have all gotten quite used to that economic environment of slow growth and low inflation and there are many professional investors, let alone non-investment professionals, who believe that is the way the world works.  Well, let me tell you, that was the exception, not the rule.  Instead, if you look at the very right side of the chart, you can see that both nGDP and rGDP have risen sharply in the wake of the Covid recession as the deluge of fiscal spending combined with, first supply chain constraints and now reshoring/deglobalization efforts, has changed the framework.  In fact, I would contend that it is in the government’s best interest to continue down this path of high nominal growth and high inflation in order to try to outgrow the increase in debt.  After all, if nGDP can grow faster than the fiscal deficit, the real value of US debt will ultimately decline.  Of course, while it would be fantastic if the bulk of that high growth was a function of gains in productivity and high real growth, the FAR more likely outcome will be persistent high inflation.





What does this mean for markets?  As we have seen over the past several sessions, equities can quickly come under pressure in this scenario, and I believe they have further to decline.  While top-line revenues can continue to grow, the problem will come from a market that is going to derate the market multiple, especially in the tech sector, from its current nosebleed levels.  High inflation will also continue to press on bond prices and the value of the long-term 60/40 portfolio is likely to continue to be eroded.  In my view, the best place to hide will be in commodities as during inflationary periods, they tend to hold their value.





An anecdote from my early days in trading is that bond traders used to believe that the “natural” yield for 10-year Treasuries was right around nGDP.  If yields rose above that level, bonds were probably a buy, and below that level, they would have a short bias.  Nominal GDP for the past two years has been 10.7% in 2021 and 9.1% in 2022.  On this basis, there is considerably further for bond prices to fall and yields to rise.  Something to keep in mind as the talking heads work to convince you to catch the falling knife that is the bond market.





Ok, so how have things behaved ahead of today’s data, and ahead of the ECB’s rate decision this morning?  Equity markets around the world have been under pressure with the Nikkei (-2.1%) leading the way as most regional markets fell sharply, notably in South Korea and Taiwan, although Chinese shares held their own on the back of still more stimulus promised by the government there.  It is clear that President Xi is growing increasingly worried about the financial situation at home.  In Europe, we are also seeing weakness, with red across the screen on the order of -1.0% or more and US futures are also pointing lower at this hour (7:30) down by -0.75% or so across the board.





Bond markets are little changed this morning with most seeing yields creep very slightly higher, maybe 1bp or so, but that is after another bond sell-off yesterday which saw Treasury yields continue their rebound from Monday’s sharp drop.  As I type, we are back at 4.97% on the 10-year and the curve inversion is down to -15bps.  As an FYI, the 2yr-30yr curve is back to flat now and I expect it is only a matter of days before the 2yr-10yr is there as well.  Yesterday’s 5yr auction was particularly poorly received with a very wide tail and concern is growing that will be the case for all coupon auctions going forward.  Yields are heading higher folks.





Oil prices are falling this morning, down -1.8%, which has basically reversed yesterday’s rally.  EIA data showed inventory builds and it seems the longer Israel holds off on its ground invasion of Gaza, the more people are willing to believe that there will be no escalation.  However, gold prices continue to rally, up another 0.4% this morning and getting ever closer to the $2000/oz level.  Meanwhile, this morning, ahead of the GDP data, both copper and aluminum are in good spirits and rising.





Finally, the dollar is clearly back in the ascendancy with USDJPY finally breaking through that 150.00 level with no sign of intervention yet, while the euro is pressing back toward 1.05 and the pound is below 1.21.  We are seeing strength across the board for the greenback, against both G10 and EMG currencies as the yield story continues to be the driver.  As to the ECB today, expectations are for no change in policy, and the real question will be whether Madame Lagarde can maintain a hawkish bias, or if the obvious weakening in the data will reveal her inherent dovishness.  If it is the latter, look for the euro to break below 1.05 before tomorrow’s close.





In addition to the rGDP data (exp 4.3%), we see Initial (208K) and Continuing (1740K) Claims as well as Durable Goods (1.7%, 0.2% ex transports).  The ECB Press conference starts at 8:45 and will be carefully watched.  Yesterday’s New Home Sales data was much stronger than expected and the BOC left rates on hold with a hawkish commentary, although the CAD was unable to gain much in the wake.  The world continues to point to higher yields to fight structural inflationary pressures.  At the same time, the dollar will retain its status and remains in demand.  While it may not rally that sharply, I see very little case for any substantive weakness in the near and medium term.





Good luck





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			Bad Dreams
		


				

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In China, the property bubble
Continues to cause Xi much trouble
So, they will add on
A trillion more yuan
Of debt, as help efforts redouble

And though Chinese markets did rise
They finished well off of their highs
Investors, it seems
Are having bad dreams
‘bout growth there and seek to downsize






Poor President Xi!  Instead of focusing all his energy on his saber rattling in the South China Sea and hinting at a Taiwanese invasion, he finds himself essentially forced to deal with the economy.  This was made clear yesterday when he made a surprise visit to both the PBOC and the SAFE (State Administration of Foreign Exchange), the two top Chinese financial institutions, and then today when the government announced an effective supplemental budget spend of CNY 1 trillion (~$137 billion) to support further infrastructure investment in the country.  





This move will increase the national government’s budget deficit for the year to 3.8%, well above the 3.0% target they had been shooting for, but obviously, the concern of continuing slow growth is being seen as a growing problem for Xi.  This is also a change from the previous process where local governments would issue debt to fund infrastructure investment and ultimately repaid that debt by selling land.  Of course, that is what led to the inflation of the massive property bubble in China, so that model is now clearly broken.





Arguably, the biggest worry is that if the domestic situation continues to deteriorate, Xi will get more adventuresome internationally as the standard national leadership political playbook is to seek to distract the population from the economic failures of a government by stoking nationalism and instigating conflict overseas.  We just saw it in Russia, and quite frankly, given the support for intensifying the war effort in the US, it is also being executed here in the US.





In the end, though, a 0.8% of GDP budget boost is unlikely to have a huge impact on the economy.  The problem the Chinese have is that they, too, have a very high debt level and are trying quite diligently to prevent it from growing out of hand.  The tradeoff there is that the amount of support is going to be restricted.  Initial economist estimates are that the package will raise GDP growth by 0.1% in Q4 and up to 0.5% in 2024 overall.  





It can be no surprise that shares in China rose on the news with the Hang Seng jumping 2.5% on the news while the CSI 300 jumped 1.3% initially.  However, both faded fast and closed higher by about 0.5%, not bad, but certainly not a huge vote of confidence.  Meanwhile, the yuan just continued is weak performance, falling another 0.2% and continuing to push against its 2% band vs. the daily CFETS fixing.





Away from that news, however, it has been dullsville this morning with pretty modest movement across both equity and bond markets around the world.  Yesterday’s PMI data indicated that the massive amount of fiscal stimulus that has been enacted in the US compared to elsewhere in the world is having the desired impact, at least from a statistical point of view, as US data continues to show relative strength compared to Europe, Japan and the rest of the G10.  However, despite those efforts, the political accolades remain absent as the national attitude is consistently measured in downbeat terms. 





And consider, if the data here are relatively better and the government is not gaining any ground, how bad it is for governments elsewhere in the world where the data is clearly worse and falling.  We continue to see populist parties from both sides of the aisle gaining in strength.  Do not be surprised to see quite a few new governments around the world over the next several years as support for incumbents continues to fall.  (It will be quite interesting to see the results of the Argentine election in a few weeks and see how Javier Milei, the upstart “anarcho-capitalist” who has promised to take a chainsaw to the government and shutter the central bank while dollarizing the economy, performs.)  A victory there could well be a harbinger of future shakeups everywhere.





Turning to markets, yesterday’s solid US performance was ultimately followed by 0.5% ish gains in China and Japan, although weaker performances elsewhere in Asia with a number of regional markets declining.  European bourses are showing very modest gains this morning, on the order of 0.1% while US futures are mostly softer at this hour (8:00), down roughly -0.4%.





The massive reversal in bonds seen on Monday is now history and we are seeing yields begin to creep back higher with Treasury yields up 3bps and similar rises throughout Europe, although Italian BTPs are the true laggard with yields there rising 6bps.  JGB yields also rose 2bps last night but have been largely capped at 0.85% by the market as there was no sign of extra intervention by the BOJ.  The yield curve inversion remains at -24bps, not quite at its tightest levels but still clearly trending toward normalization.





One thing to consider about the Treasury market is the fact that the US trade deficit has been steadily shrinking amidst the efforts at reshoring and all the CHIPS act spending on manufacturing capacity, as well as the simple fact that US energy exports continue to be quite robust.  The point is that one of the key demands for Treasury bonds in the past was the recycling of all those deficits, but if the deficits shrink, then there is less to recycle and therefore less demand for Treasuries.  Combine this process with the fact that the government continues to increase the amount of issuance and it is not hard to conclude that bond yields have further to rise over time.  The fact that an oversold market responded to a major psychological level does not mean the bond market move has ended.  Rather I would argue it has simply paused and yields will once again climb going forward.





Turning to the commodity markets, oil is marginally higher this morning, up 0.3%, but that is after another sharp decline yesterday as the market appears to believe that the odds of a widening of the Israeli-Palestinian conflict are shrinking amid growing pressure from organizations around the world.  Add to that the signs of weaker economic activity which implies reduced demand, and it is easy to understand why oil has retraced. However, inventories fell again last week, and the structural issues of supply remain in place.  The big picture remains for further strength over time in my eyes.  As to the metals markets, gold continues to benefit from its haven status, edging higher by 0.25% this morning while copper is suffering on the weaker growth story, falling -0.4%.





Finally, the dollar is stronger overall with the euro > 1% lower than its recent highs Monday afternoon which were seen in the wake of the bond market rally that day.  USDJPY is right back below 150.00 although it has not yet touched the level since early this month which was followed by what appeared to be intervention.  But generally, we are seeing the dollar gain against both G10 and EMG rivals as US rates once again edge higher, 2yrs as well as 10yrs.





On the data front today, New Home Sales (exp 680K) are due at 10:00 as well as the Bank of Canada rate decision where no change is expected.  We also see EIA oil inventory data later this morning and then Chairman Powell speaks late this afternoon.  I continue to believe it is unlikely that he will add anything to his message from last week.  As such, it is a status quo day.  If yields continue higher, look for the dollar to follow.  But I have a feeling that there will be very little movement today overall.





Good luck





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			Much Maligned
		


				

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Though pundits worldwide have opined
The world’s in a terrible bind
Investors don’t seem
Concerned ‘bout that theme
With naysayers still much maligned

But trees cannot grow to the sky
And rallies, at some point, must die
If Jay and his kin
Do not soon begin
To cut rates, bulls will start to cry






I guess the hint at peace negotiations in the Israeli-Palestinian conflict was enough to get the bulls back in front of the move.  Or perhaps it was the comments from Philly Fed president Patrick Harker, who seems to be one of the most dovish on the FOMC these days.  After explaining, “Small firms are really struggling with access to capital,” and “some of the bankers I’ve talked to are concerned that their business plans just aren’t going to be able to make it at the higher rates” he gave us the money line (my emphasis), “This is why we should hold rates steady, we should not at this point be thinking about any increases, because if that’s true – and it is true – then we should let that ride out.”  So here is the first clear signal for an FOMC member that they are done.  Now, Harker is a voter, so that matters, but it seems pretty clear that nobody is expecting a rate hike in early November.  Arguably, the big question is what will happen in December and that is still very far away.





However, that signal implying the Fed is well and truly done was sufficient to boost risk assets, well at least to boost equity markets with US markets all higher by 1% or so while European bourses had smaller gains, on the order of 0.3%.  Bond markets, meanwhile, remain under pressure as the hint of peace talks removed some of the need for a haven, and our Treasury Secretary explained that “we can certainly afford two wars.”  If you were wondering what the fiscal situation was, she seems to have things under control.  However, beware that paying for two wars by issuing yet more debt seems like it may have a significant negative impact on bond prices.  With this attitude in Washington, perhaps we should be looking for 6% in the 10-year Treasury yield soon.





And that’s really the crux of the issue, it seems that the stock market and the bond market are pricing very different outcomes.  Stocks continue to trade well as we enter earnings season and investors remain sanguine about any potential economic downturn.  There is a great deal of belief that if the economy does reverse course from its recent apparent strength, the Fed will step right back into the market, cut rates and end QT, if not restart QE.  Meanwhile, the bond market continues to look at the still too hot inflation data and combines that with the prospect of still more debt issuance as Secretary Yellen funds two wars and more social programs and is quite concerned.  Perhaps it is my age and experience, but alas, I fear the bond market is correct.  The prospects for better investment performance in the near-term seem limited to me.





For now, given the lack of significant new news or data, as well as the anticipation of Chairman Powell’s comments come Thursday, markets in Europe and US futures are biding their time.  Remember, too, that we see US Retail Sales as well as Canadian CPI this morning at 8:30, so either of those could well be a new catalyst.  But until then, a look at markets shows that equities are mixed in Europe with the FTSE 100 slightly higher while continental bourses are slightly softer while US futures are a touch softer at this hour (6:30), down about -0.3%, as they consolidate after yesterday’s rally.





Bond markets, however, continue to fade as the benefits accorded to stocks (potential end to Israeli war and hoped for better earnings) are anathema to bond investors.  Treasury yields are higher by 5bps this morning, leading the way higher while European sovereigns are all higher by between 3bps and 6bps with the Bund-BTP spread widening back above 200bps.  Last night saw JGB yields edge higher to 0.77%, as the new Mr. Yen, Kanda-san, once again explained that intervention was possible as was the idea of raising interest rates.  (Yes, I know that the MOF doesn’t control interest rates, but apparently, he doesn’t.)





Turning to commodities, oil continues to consolidate its recent gains, essentially unchanged today, but still above $85/bbl with a major concern that any escalation in fighting in Israel may spread to OPEC producers.  That certainly cannot be ruled out, and remember, the US has already wasted utilized its SPR so there is no additional supply likely to emerge in that situation.  As to the metals markets, gold (+0.2%) continues to consolidate after last week’s impressive rally while both copper and aluminum are softer this morning on economic concerns.  Here too, there seems to be a disconnect between investors and traders in stocks and commodities with the former remaining quite bullish overall while the latter are anything but.





Finally, the dollar is also biding its time this morning although it is beginning to creep higher.  Two particular movers are the pound (-0.5%) which has responded to slightly softer payrolls and wages data opening some room for the BOE to back off a bit from its tightening schedule, and NZD (-0.7%), where CPI was quite a bit softer than forecast.  Meanwhile, USDJPY seems frozen just below 150 as the threats of intervention are currently sufficient to offset the ongoing carry opportunities.  In this case, I continue to see room for the dollar to rise as intervention is only ever a temporary solution and I cannot see a reason why the Fed would object to a strong dollar given its inflation fighting impact.  





In the EMG space, the dollar is broadly higher with the renminbi back above 7.32 and pushing toward the lows (dollar highs) seen last month.  But KRW, THB, TWD and SGD are all softer as well.  Meanwhile in LATAM, we are seeing the same general price action in BRL and MXN both having weakened more than 9% through August and September and both now edging a bit higher lately.  However, there is no indication that the broader dollar strengthening trend has ended.





As mentioned above, this morning we see Retail Sales (exp 0.3%, 0.2% ex autos) and Canadian CPI (exp 4.0%, core 3.3%).  We also hear from Williams, Bowman, Barkin and Kashkari throughout the day as virtually every FOMC member wants to get on the tape before the quiet period begins on Friday.  In the end, consolidation seems the likely activity for now barring something new in Israel or a blowout number this morning.  Net, I still like the dollar overall.





Good luck





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			Into the Abyss
		


				

			Posted on  by 		

			


		

		

In Washington, something's amiss
As hardliners say with a hiss
Let government close
As we don’t oppose
A tumble into the abyss

The reason that markets might care
Is data will then become rare
Thus, how will the Fed
Keep looking ahead
If rear-facing data’s not there?






As this is not a political commentary, I generally try not to focus on these issues.  However, periodically, they impact the economics and the markets so I must.  As we approach the fiscal year-end for the US this Saturday, there are still a number of appropriation bills that have not passed Congress and been signed into law.  Some of the hardliners in the Republican majority in the House seem to be willing to die on this particular hill, although as we are talking politics, and there are still two days left before it becomes a fait accompli, things are subject to change.  





But the issue for markets has far less to do with the actuality of the government shutting down and entirely to do with the fact that the Bureau of Labor Statistics and Commerce Department, the source of most government data, will be shut down and so not be able to publish the monthly numbers.  Given that the Fed has repeatedly told us that they are data dependent, on what will they base their decisions if there is no fresh data to help guide them?  





The inherent problem with data dependence is that all the data published by the government is backward looking, reporting what happened in the past week/month/quarter, and the Fed uses its numerous econometric models to extrapolate how that will play out in the future.  History shows us, though, that the Fed’s models, especially lately, have not been terribly accurate.  Does anyone remember transitory inflation?  (Every time I go to the grocery store and see the price of staple items it crosses my mind.  How about you?)  Thus, if I were to analogize their process, it is like driving a car forward while looking only in the rearview mirror and the steering mechanism doesn’t work properly. 





At any rate, this story is going to dominate for a while.  Chairman Powell speaks this afternoon at a townhall with educators and he will be taking questions from the audience.  You can be sure that reporters will be there and there will be a question about how the Fed will handle the lack of data in the event of a shutdown.  This is unlikely to dominate the market narrative quite yet, but if the shutdown does happen, Monday could see some impact.  We shall see.





In the meantime, risk remains under pressure around the world as there are three current market features that are dissuading investors from jumping in, and in many cases pushing them to the sidelines.  





First is the price of oil, which rose 4% yesterday and is basically unchanged this morning, retaining all of this gains.  We are now back to levels not seen since July 2022 when oil was falling from the post Ukraine invasion spike while the Biden administration was flooding the market with SPR reserves.  Given the SPR is back to levels last seen in 1983, shortly after it was initiated, it seems there is less room for the Administration to repeat this performance.  At the same time, there has been no indication that OPEC+, and the Saudis specifically, are getting set to open the taps again.  Rising oil prices impact everything as they are an excellent proxy for the price of energy writ large.  And everything requires energy to keep going.  If it costs more to keep the lights on or ship products, it is going to work its way into the price of retail items.





Second is US yields, which we proxy with the 10-year Treasury bond.  This morning it is trading at 4.65%, continuing its recent move and, in truth, looking like it is accelerating it.  Since the beginning of September, the 10-year yield is higher by 55bps, a very large move, and that is dragging yields higher around the world.  For instance, German bunds, French OATs, and UK gilts are all trading at decade-plus high yields, and even worse for the ECB, Italian BTPs, are seeing their spread to bunds widen back toward 200bps.  You may recall that in July 2022 the ECB created a program called the Transmission Protection Instrument (TPI) which was designed to essentially roll maturing bund positions from the ECB’s balance sheet into Italian BTPs to support that market and prevent the euro from exploding.  Once that got going it was quite effective at moderating that spread, and things seemed fine.  But recently, the Italian fiscal situation has become increasingly weakened and the market is pushing on this issue again.  The point is the market is focusing on more risks and thus risk appetite is waning.





Finally, the dollar continues to rise.  Using the Dollar Index (DXY) as a proxy, it is currently trading well above 106 and taken out much technical resistance.  While it is a bit softer this morning, with the euro (+0.4%) and pound (+0.5%) both bouncing a bit along with the yen (+0.2%), this trend remains very clear.  (see graph courtesy tradingeconomics.com)










In fact, last night USDJPY touched 149.70, a new high for the move and that triggered some further comments from Japanese FinMin Suzuki that indicated he was close to the next stage of intervention known as “checking rates”.  This is the process by which the BOJ calls out to the big banks in Tokyo asking for a price in USDJPY but does not deal.  However, the simple fact of asking for the price gets these banks to sell dollars for their own accounts and they then spread the word that the BOJ is “checking rates” which all in the market know is a sell signal.  So, last night, when the dollar hit that high level, Suzuki was on the tape saying that might be the next step and the dollar fell back a bit.





Remember, though, intervention will only matter if it is concerted, with all the central banks, especially the Fed involved, and really only if monetary policies change.  And it is the latter that seems the least likely right now.  So, if when the dollar trades above 150 expect some fireworks, but unless there are other changes, it will be temporary.  Hedgers, be prepared.





And that is the situation as we head into today’s session.  There is a bunch of data coming this morning starting with Initial (exp 215K) and Continuing (1675K) Claims, as well as our third look at Q2 GDP (2.1%).  In addition to Chair Powell this afternoon, we hear from Chicago Fed president Goolsbee this morning and Governor Cook early this afternoon.  The most recent comments from both of them indicate that more rate hikes may well be necessary, and neither is in a hurry to cut rates.  





Yesterday saw a pretty flat day in the equity markets in the US and futures this morning are also little changed.  however, there is growing concern, as I outlined above, that risk is becoming riskier and that the safety of short-dated US paper, which currently yields 5.5% or more, is a very good place to be invested for the time being.  To my eye, the trends outlined above, higher oil, yields and a stronger dollar, remain intact.  As long as that is the case, equity markets are going to struggle.  As to the dollar, we will need substantial policy changes to turn that ship around, and right now, there is no sign that is on the horizon.





Good luck





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