Tag Archives: #higherrates

Democracy’s Died

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There once was a fellow named Trump
Whose plan was, Joe Biden, to dump
He started last night
By winning the fight
And heads to New Hampshire to stump

Political pundits worldwide
Now claim that democracy’s died
But markets don’t seem
In touch with that theme
Instead, interest rates are their guide

The Iowa caucus results can be no surprise to anyone as the polls were quite clearly in Donald Trump’s favor.  In the end, he won with slightly more than 50% of the vote while Governor DeSantis came second, Ambassador Haley was in third and Vivek Ramaswamy was a weak fourth.  Ramaswamy has now dropped out of the race and thrown his support behind Trump.  Next week, is the New Hampshire primary and then two weeks later is the South Carolina primary.  After that, comes Super Tuesday in early March, and quite frankly, it would be shocking, at this point, if Trump did not wrap up the nomination by then.

I only mention this because of all the elections this year, arguably the US presidential one is the most impactful on the world at large as well as financial markets.  I will remind you of the equity market behavior in 2016 when Trump was elected the first time and as the evening progressed, the initial response was to see equity futures fall sharply as it became clearer that Trump was going to win, but by the time the markets opened in NY, they had completely reversed and rallied quite sharply, several percent.  Ultimately, I would not be surprised to see more market impacts this year as well.  It is one of the reasons that I believe the major theme this year is going to be more volatility across all markets than we have seen in the past several years combined.

However, right now, we are too early in the cycle and there has been no change of views or broad polling results, so investors are going to focus elsewhere, namely central bank actions.  This brings us to the question of will the Fed actually be cutting interest rates six times in 2024, or more accurately, will they be reducing the Fed funds rate by 150bps?  Funnily enough, I think that may be the least likely outcome of the array of possibilities that exist.  Instead, I expect that the futures market is pricing in an almost binary outcome.  On the one hand, the Fed remains true to their comments that inflation remains too high and while some cuts will come, it is very premature, so perhaps only one or two cuts this year.*  On the other hand, the recessionistas are correct, a hard landing is coming and the Fed is going to have to cut by 300bps or 350bps to support the market.  Play with these probabilities and it is pretty easy to come up with a scenario that shows 150bps of cuts this year.

But for now, whatever my views on how the Fed and other central banks are going to behave, the only important thing is what the market is anticipating.  This takes us back to the market’s assumption about the Fed’s reaction function regarding all the data that is coming our way.  Hence, the fact that the market largely ignored what appeared to be a hotter than expected CPI print last week, but jumped all over a softer than expected PPI print is telling in and of itself.  The market is desperate for the Fed to cut rates which will open the doors for all the other central banks to cut rates.

And in truth, I think this is exactly what we should expect for the time being.  The market is all-in on the idea that not only has the peak in inflation been seen, but that it is quickly falling back to the 2% target that is almost universal.  And they are all-in on the idea that central banks will be able to lower rates back to much more comfortable levels for those in debt while supporting risk asset prices.  My take is we will need to see a long series of data that indicates anything other than this scenario before market views change.  So, any data that indicates inflation remains sticky will be ignored, while data that indicates it is falling sharply will be regurgitated constantly.  The same will be true in the employment and production data.  All I’m saying is we need to be prepared to see certain data that doesn’t fit the narrative get completely ignored for now.  Manage your risk accordingly.

As to the overnight session, things have been less optimistic overall with most stock markets in Asia under pressure, even Japan (Nikkei -0.8%) and Hong Kong (-2.2%) really feeling pressure although mainland Chinese shares held in there after word that the Chinese government would be issuing an emergency CNY 1 trillion (~$139 billion) of debt to fund spending domestically.  As to Europe, all red there, albeit only on the order of -0.4% across the board and US futures are also lower this morning, something around -0.25% at this hour (7:45).

In the bond market, after the US holiday prevented any changes of note yesterday, we see Treasury yields backing up 7bps this morning, a similar move to what we saw in Europe yesterday.  Arguably, this seems like a catch-up move.  In fact European sovereign yields are essentially unchanged on the day as German GDP data confirming the recession of 2023 did nothing to change views, nor surprisingly, did slightly better than expected UK employment data where wage growth was seen rising less rapidly than anticipated.  JGB yields remain moribund and the idea that the BOJ is going to change anything seems a more and more distant prospect for now.

Oil prices (+0.6%) are a touch higher amid further threats from the Houthis as well as some missile attacks by Iran on areas in Iraq and Syria.  I cannot keep up with all the different allegations here, but we cannot ignore the fact that things seem to be escalating.  This cannot be a good outcome for oil prices, or perhaps more accurately, seems likely to push them higher.  The higher interest rates are weighing on precious metals with gold and silver both lower, but surprisingly, copper and aluminum are both rallying this morning.

Finally, the dollar is flexing its muscles this morning, higher against all its counterparts in both the G10 and EMG spaces.  AUD, NOK and SEK have all declined by -0.8% or so, leading the way in the G10 space, although -0.6% covers the bulk of the rest of the bloc.  In the EMG space, KRW (-1.25%), PLN (-1.0%) and MXN (-1.0%) are the laggards across an entire bloc that is under pressure.  This is all about the dollar this morning with no idiosyncratic stories to drive things.

On the data front, we only have the Empire State Manufacturing Index (exp -5.0) and we hear from Fed Governor Waller as well at 11:00.  It seems to me that the market has really gone a bit too far in its bullish beliefs and today is a bit of a correction.  Unless we start to see a lot more push back regarding policy ease though, I expect this movement will be short-lived.  Although ultimately, I believe that we will see a weaker economy, higher inflation and weaker asset prices, I do not think that is the near-term view.  Rather, I expect we will see more dip buying for risk assets by tomorrow at the latest.

Good luck
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*I am well aware that the recent dot plot indicated a median expectation of 75bps of rate cuts this year, but do not forget that the dispersion of that grouping was quite wide, with one assuming no cuts and several assuming just one or two.  I feel it is very weak thinking to say the Fed has indicated three rate cuts this year, they have done no such thing!

A ZIRP Doctrinaire

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The lady who once ran the Fed

And, Treasury, now runs instead

Explained higher rates

Right here in the States

Are something that she wouldn’t dread

But when she was Fed Reserve chair

And she had a chance to forswear

That rates should stay low

Her answer was, no

As she was a ZIRP doctrinaire

“If we ended up with a slightly higher interest rate environment it would actually be a plus for society’s point of view and the Fed’s point of view.  We’ve been fighting inflation that’s too low and interest rates that are too low now for a decade.  We want them to go back to a normal interest rate environment, and if this helps a little bit to alleviate things then that’s not a bad thing, that’s a good thing.”  So said Treasury Secretary Janet Yellen in a Bloomberg News interview as she was returning from the G7 FinMin meeting in London.

What are we to make of these comments?  Arguably, the first thing to note is that the myth of Fed independence is not merely shattered, but rather that the Treasury now explicitly runs both fiscal and monetary policy.  Can Chairman Powell resist a call for higher rates from his boss?  And yet this is diametrically opposed to everything we have heard from the majority of the FOMC lately, namely until “substantial further progress” is made toward achieving their key goal of maximum employment, policy is going to remain as is.  In other words, they are going to continue to buy $120 billion per month of Treasury and mortgage backed paper.  However, QE’s entire raison d’etre is to keep rates lower.  Does this mean tapering is going to begin soon?  Will they be talking about it at next week’s FOMC meeting?  Again, based on all we had heard up through the beginning of the quiet period, there was only a small minority of FOMC members who were keen to slow down the purchases.  Is Yellen a majority of one by herself?

The other thing that seems odd about this is that elsewhere in the interview she strongly backed the need for the proposed $4 trillion of additional government spending, which is going to largely be funded by issuing yet more Treasury debt.  I fail to understand the benefit, for the Treasury (or taxpayers) of spending more on debt service due to higher interest rates.  Or perhaps, Yellen was simply saying she thought spreads over Treasuries should rise, so others paid more, but the US still paid the least amount possible.  Somehow, though, I don’t believe the latter sentiment is what she meant.  (A cynic might assume she was short Treasuries in her PA after Friday’s data and was simply looking for a quick profit.  But, of course, no government official would ever seek to gain personally from their official role…right?)

Regardless of her motivation, the market took it to heart and 10-year Treasury yields have backed up 2.5 bps this morning, although that is after Friday’s very strong rally (yields fell more than 7 basis points) on the back of the weaker than expected NFP report convinced the market that tapering was now put off for much longer.

Which brings us to Friday’s data.  Once again, the NFP report missed the mark, with a gain of 559K, well below the 675K expected.  Interestingly, despite last month’s even bigger miss, revisions were miniscule, just 27K higher.  So, at least according to the BLS, job growth is not nearly as fast as previously expected/hoped.  What makes this so interesting was last week’s ADP data showed nearly 1 million new jobs were taken.  It appears that Covid has had a significant impact on econometric models as well as the economy writ large.  Of course, the stock market took this goldilocks scenario as quite bullish and we saw equity markets rally nicely on Friday.

In sum, Yellen’s comments seem a bit out of step with everything we had previously understood.  There is, though, one other possibility.  Perhaps Ms Yellen understands that inflation is not going to be transitory and that the Fed may well find itself forced to raise rates to address this situation.  If this is the case, then the fact that the Treasury Secretary has already explained she thinks higher rates would be “a good thing,” it leaves the Fed the leeway needed to address the coming inflationary wave.  One thing is certain, the inflation discussion is going to be with us for quite a while yet.

Market activity overnight has been fairly dull despite the Yellen comments, with equity markets mixed in Asia (Nikkei +0.3%, Hang Seng -0.45%, Shanghai +0.2%) although European markets have started to climb after a very slow start (DAX +0.2%, CAC +0.3%, FTSE 100 +0.3%).  US futures are mixed to slightly lower as NASDAQ futures (-0.35%) feel the force of potentially higher interest rates, while the other two indices are little changed.  (Remember, tech/growth stocks are akin to having extremely long bond duration, so higher interest rates tend to push these stocks lower.)

As mentioned, Yellen’s comments have led to Treasuries falling, and we have seen the same behavior in Europe with sovereigns there looking at yields higher by between 1.5 and 2.0 bps at this hour.  Higher interest rates have also had a negative impact on commodity prices with oil (-0.4%), gold (-0.25%), copper (-1.0%) and aluminum (-1.0%) all under pressure.  The one exception in the commodity space is foodstuff where the grains are all higher by at least 1.5% this morning.

Finally, the currency market is mixed although arguably leaning toward slight dollar weakness.  In the G10, the most notable mover is NOK (+0.5%) which is gaining despite oil’s weakness on the assumption that it will be the first G10 country to actually raise interest rates, with Q4 this year now targeted.  But away from that, the other 9 currencies are within 0.2% of Friday’s close with no stories of note.  In the emerging markets, MXN (+0.85%) is the runaway leader after yesterday’s elections handed AMLO a loss of his supermajority in the Mexican congress.  It seems investors are glad to see a check on his populist agenda of spending.  Beyond that, we see TRY (+0.5%) benefitting from hopes that President Biden’s meeting with Turkish President Erdogan will result in reduced tensions between the two countries.  And lastly, KRW (+0.3%) continues to see investment inflows drive the currency higher.

On the data front, there was nothing of note overnight, but this week has some important activities, namely US CPI and the ECB meeting.

Tuesday NFIB Small Biz Optimism 100.9
Trade Balance -$68.5B
JOLTS Job Openings 8.3M
Thursday ECB Meeting
CPI 0.4% (4.7% Y/Y)
-ex food & energy 0.4% (3.4% Y/Y)
Initial Claims 370K
Continuing Claims 3.7M
Friday Michigan Sentiment 84.2

Source: Bloomberg

Clearly, all eyes will be on CPI later this week as while widely expected to be rising again due to base effects, it is important to remember that it has risen far faster than even those expectations.  While the Fed remains quiet, the ECB is likely to reiterate that it is going to be keeping a ‘stepped up pace’ of asset purchases.  Although there is a great deal of belief in the dollar weakness story, I assure you, the ECB is not interested in the euro rallying much further.  Just like the Chinese, it appears most countries have had enough of a weak dollar.  Until the next cues, however, it seems unlikely that there will be large movement in the FX market.

Good luck and stay safe

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