Tag Archives: #higheryields

Got Smote

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There once was a poet that wrote
‘Bout bonds and the fact they got smote
So, yields, they did rise
And to his surprise
Most pundits, this news did promote
 
Now turning to stories today
The biggest one, I’d have to say
Is how, in Japan
Ishiba’s grand plan
Has failed, thus he’ll be swept away

 

The number of stories this morning regarding the synchronous rise of long-dated bond yields around the world has risen dramatically.  While yesterday, I highlighted this fact, I certainly didn’t expect it to be the key narrative this morning.  But such is life, and virtually every news outlet is focusing on the subject as both a reason for the poor equity performances yesterday as well as a way to highlight government profligacy.  I do find it interesting, though, that the same publications that push for more spending for their preferred causes have suddenly become worried about too much government spending.  But double standards are nothing new.   A smattering of examples show Reuters, Bloomberg and the WSJ all feigning concern over too much government spending.

I say they are feigning concern because all these publications are perfectly willing to support excess government spending if it is spent on the things they care about.  Regardless, the fact that this has become one of today’s key talking points is evidence that some folks are starting to recognize that trees cannot grow to the sky.  Even though almost every major central bank is in easing mode, long-term yields keep rising.  Alas, the almost certain outcome here, albeit likely still well into the future, is some form of yield curve control as central banks will be forced to prevent yields from rising too high lest their respective governments go bust.  I expect that the initial stages will be regulations requiring banks and insurance companies, and maybe private, tax-advantaged accounts like IRA’s and 401K’s, to hold a certain percentage of Treasuries.  But I suspect that eventually, only central banks will have the wherewithal to prevent runaway yields.  Welcome to the future; got gold?

However, you can read about this everywhere, and after all, I touched on it yesterday so let’s move on.  Government stability/fragility is the topic du jour in this poet’s eyes.  We already know that the French government is set to fall on Monday when PM Bayrou loses a confidence vote.  It is unclear what comes next, but French finances are in bad shape and getting worse and they don’t print their own currency.  This tells me that we could see a lot more social unrest in France going forward given the French penchant for nationwide strikes.  

But a story that has gotten less press is in Japan, where PM Ishiba saw the LDP majority decimated in the Upper House two weeks ago and is now heading a minority government as the LDP does not have a majority in either house in the Diet.  One of the key members of the LDP, and apparently the glue that was holding together the fragile coalition was Hiroshi Moriyama, the LDP Secretary General, and he is now resigning along with several of his lieutenants, so it appears that Japan’s government is about to fall as well.  The upshot here is that the BOJ seems unlikely to raise interest rates given the political uncertainty, which is not only pressuring long-dated JGB’s but also the yen. (see chart below from tradingeconomics.com)

While I have not written extensively about the UK’s government, the situation there is quite similar, with massive fiscal problems driving yields higher while the government focuses on removing the right of free speech amongst its people if that speech is contra to the government’s policies.  While the next UK election need not be held for another 4 years, my take is it will be much sooner as PM Starmer has destroyed his legitimacy with recent policy decisions and will soon be unable to govern.  It will only be a matter of time before his own party turns on him.

The governments in Japan, France and the UK are all under increasing pressure as their policy prescriptions have not tackled the key problems in their respective economies.  Inflation in Japan and the UK and benefits in France need to be addressed, but it is abundantly clear that the current leadership will not be able to do so effectively.  Once again, please explain why people are so bearish the dollar, at least in the long run.  While inflation will be higher worldwide and fiat currencies will all suffer vs. real assets, on a relative basis, the dollar doesn’t appear so bad after all.

Ok, let’s move on to the overnight activity as it gets too depressing highlighting all the government failures around the world.  While US stocks closed above their worst levels of the session, they were all lower yesterday.  That bled into Asia with Japan (-0.9%), Hong Kong (-0.6%) and China (-0.7%) all falling with worse outcomes in some other parts of the region (Australia -1.8%, Philippines -0.75%) although there were winners as well (Korea, India, Taiwan) albeit in less impressive fashion.  Perhaps the surprise was Chinese underperformance after PMI Services data there printed at its highest level since May 2024.

But whatever the negativity that existed in Asia was, it did not translate to European shares as they are all higher (CAC +1.0%, DAX +0.8%, FTSE 100 +0.55%, IBEX +0.2%).  Now, clearly it is not confidence in government activity that has investors excited.  The only data of note was Services PMI, which was mostly as expected except in Germany where it fell to 49.3, far lower than the initial estimate of 50.1 and based on the chart below, seemingly trending lower.

Source: tradingeconomics.com

US futures, too, are higher this morning, with gains of 0.5% to 0.75% for the S&P and NASDAQ.

You won’t be surprised that bond yields continue to drift higher, even in the 10-year space with Treasuries higher by 2bps, although most European sovereign yields have edged down by -1bp in the 10-year space.  It is the longer dated yields that continue to see the most pressure with 30-year yields across the US, Europe and Japan all pushing to new highs for the move, and in the case of Japan, new all-time highs.

Source: tradingeconomics.com

This, of course, is the underlying story for virtually all markets right now.

In the commodity markets, oil (-2.1%) has given back yesterday’s gains after reports that OPEC+, which is meeting this weekend, will be raising their output yet again.  Whatever the situation is in Russia, whether Ukrainian attacks are reducing supply or not, it seems clear that OPEC is unperturbed and wants to pump as much as possible. In the metals markets, gold (+0.3%) has set another new all-time high and appears to be breaking out from its recent consolidation pattern.  I am no market technician (I’m a poet after all), but a consensus seems to be forming that $3700 is coming soon and $4000 will be achieved by early next year.

Source: tradingeconomics.com

The rest of the metals space is little changed this morning with silver holding at its 11-year highs and copper treading water at the levels that existed pre-tariff threats.

Finally, the currency markets, which saw the dollar rally sharply yesterday, are taking a breather with the dollar giving back some of those gains amid a consolidation.  In the G10, movement is 0.2% or less, so really nothing and in the EMG bloc, HUF (+0.6%), KRW (+0.5%) and ZAR (+0.3%) are the biggest gainers, with the latter following gold, while traders see the central bank in Hungary maintaining higher rates to fight still, too high inflation of 4.3%.  As to Korea, better than expected GDP data helped drive inflows to the currency.

On the data front today, we see JOLTs Job Openings (exp 7.4M) and Factory Orders (-1.4%) this morning and the Fed’s Beige Book is released at 2:00pm.  We also hear from two Fed speakers, which given the row over Governor Cook’s tenure at the Fed, may be interesting to see.  The market continues to price a 92% probability of a 25bp cut in two weeks’ time, but I suspect that Friday’s NFP data may be the ultimate arbiter there.

I cannot look at the world and conclude that the US is the biggest problem around.  However, if we do see weak data on Friday and the market starts to price 50bps of cuts by the Fed, the dollar will decline in the near term.  But longer term, the more I read, the more bullish I get on the greenback, at least relative to other currencies.

Good luck

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Vexation

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The ‘conomy just keeps on humming
So, confidence, not yet is coming
How long will rates stay
Where they are today?
And will stocks keep getting a drumming?
 
The problem remains that inflation
Is causing Chair Powell vexation
It’s sticky and hot
Which really is not
What he needs to get his ovation

 

Boy, I go away for a few days and look what you’ve done to the markets!  When last I wrote, while there was a sense of shakiness in risk assets, it hardly appeared terminal.  But now…. The bears are out in force it seems, fear is rising rapidly amid investors while greed is running for its life.

I tried to ignore market goings on while I was away for the back half of last week, but the news was overwhelming.  My brief recap is simply, lots more Fed speakers have figured out that measured inflation is not heading lower, and that the decline during the second half of last year is turning into the aberration, not the rebound so far in 2024.  This week we will see the PCE report on Friday, and while that is typically between 0.5% and 1.0% lower than CPI, it is not going to come close to their target.  

As I wrote several weeks ago, following Powell’s press conference and subsequent speeches, regardless of the fact that there is no indication price pressures are abating, he is still keen to cut rates.  However, the weight of the recent data has caused many of his colleagues on the FOMC to change their tune.  The most recent was NY Fed President Williams who also indicated that a rate hike in the future cannot be ruled out.  Remember, Governor Bowman discussed that idea the week before last.  Going back to my prognostications at the beginning of the year, I had anticipated one cut at most during the first half of the year, but that rates, and bond yields, would be higher by Christmas.  I still like that call, although I am losing my enthusiasm for the cut.  And so is everybody else!

If rates simply stay where they are, I suspect that the recent equity selloff will moderate as it is clearly more fully priced into markets given the consistency with which we have heard that story in the past several weeks.  However, beware if the next step is higher.

Meanwhile, the week is off to quite a slow start with most equity markets rebounding from last week’s declines as fears of further escalation in the middle east abate.  The Israeli response to the Iranian response was muted and market participants have turned their attention elsewhere.  This can best be seen in the commodities markets as both oil (-0.5% today, -4.2% in the past week) and gold (-1.3% today, -1.0% in the past week) are retreating from their recent highs.  However, all is not completely well as we continue to see US Treasury yields on the high side and climbing (10yr +3bps) as more and more investors demonstrate concerns over inflation’s stickiness.

There was virtually no economic news overnight and a remarkably, though welcome, minimum of central bank speakers.  Remember, the Fed is in their quiet period this week up until their meeting next Wednesday, so everyone needs to make up their mind on their own.  With that in mind, here’s what we saw last night.

Equity markets in Asia rebounded nicely with the Nikkei (+1.0%) and Hang Seng (+1.75%) both performing well although shares on the mainland (CSI 300 -0.3%) didn’t join the party.  Elsewhere in the region, only Taiwan was in the red with every other nation enjoying the bounce.  As to Europe, this morning, the screen is green with gains ranging from the CAC (+0.35%) to the FTSE 100 (+1.45%) and everything in between.  Again, this certainly feels like a relief rally given the absence of new information.  Finally, the US futures markets are all higher this morning on the order of 0.5%, something I’m sure we are all happy to see.

In the bond markets, Treasury yields are leading the way with European sovereigns also higher by between 2bps and 4bps, clearly being dragged by Treasuries.  We did hear from Banque de France president, and ECB member, Villeroy, that he felt a June cut was certain and he was looking for more afterwards.  Interestingly, he made the argument that the ECB’s job was to ensure economic activity was helped as much as possible while targeting inflation.  That is a different take than I’ve heard any ECB member discuss before, although I am sure it is what many are thinking.  

Perhaps the most interesting move last night was JGB yields climbing 4bps and moving up to 0.88%.  This is their highest level since November when they flirted with the 1.0% “cap” that required a massive bond buying exercise by the BOJ.  With USDJPY grinding ever so slowly toward 155.00, there is a school of thought that the BOJ will seek higher yields to defend the yen.  However, my take is any yen defense will be in the form of intervention and be described as a smoothing activity.  The current Mr Yen, Masato Kanda, has discussed the idea of a rise in USDJPY of 10 yen in a month as being too quick and worthy of a response.  Granted, since its recent nadir of 146.85 on March 11, that milestone has almost been reached, but that low was a very short-term dip and while the yen has declined consistently all year, as you can see from the chart below, the pace has not nearly been that quick.  In fact, I would argue the pace has been steady all year, and virtually identical to that of the dollar index which indicates this is not a yen problem, it is a dollar problem.

Source: tradingeconomics.com

Turning to the dollar, it is modestly higher overall this morning with the noteworthy mover the pound (-0.5%) after we heard from BOE member Ramsden explaining that he saw the risks of inflation remaining high were diminishing and that rate cuts were coming soon.  While one of his colleagues, Megan Greene, gave the opposite spin, apparently in a misogynistic response, the market took Mr Ramsden as the more important voice on the matter.  As well as the pound, we have seen the euro (-0.2%) and its EEMEA acolytes (PLN -0.5%, CZK -0.6%) slide.  Otherwise, there is a mixture of lesser movements with a few currencies managing to gain strength, notably AUD (+0.3%), NZD (+0.3%) and CAD (+0.2%).  Summing up the currency markets, for the time being, with the Fed sounding increasingly hawkish and other central banks turning dovish, it seems like it is hard to bet against the greenback.  That doesn’t mean we will not see a short-term selloff, just that the trend, as you can see in the chart above, remains firmly higher for the buck.

On the data front, there is not a great volume of information, but PCE will certainly keep us all riveted to the screen Friday morning.

TodayChicago Fed Nat’l Activity0.09
TuesdayFlash Manufacturing PMI52.0
 Flash Services PMI52.0
 New Home Sales668K
WednesdayDurable Goods2.5%
 -ex Transport0.3%
ThursdayInitial Claims215K
 Continuing Claims1814K
 Q1 GDP2.5%
 Q1 Real Consumer Spending2.8%
FridayPCE0.3% (2.6% Y/Y)
 -ex food & energy0.3% (2.6% Y/Y)
 Michigan Sentiment77.8

Source: tradingeconomics.com

With the absence of Fed speakers, a blessing in my view, market participants will likely be taking their cues from earnings as well as activities elsewhere.  In the end, nothing has changed my view on the dollar where higher for longer suits both the rate and dollar outcome.

Good luck

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Obliteration

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The chance of a much wider war
Is something we need to plan for
Thus, havens ought be
A key thing we’ll see
Demanded, as prices will soar
 
The thing is that war and inflation
Have partnered through history’s duration
While prices may rise
Most nations surmise
That’s better than obliteration

 

The weekend just passed saw what could be the next step to a wider war in the Middle East after Iran launched a massive air assault on Israel.  While it seems to have been fully repelled, with limited damage and injury, the world is waiting on tenterhooks to see if there will be a counterattack by the Israelis.  In a different time, with a different set of leaders around the world, perhaps the next steps would be talks and negotiations designed to stop the madness.  But in the current world, with the current global leadership, there is no sign that anyone is capable of driving that particular outcome.

With this in mind, I think it is important to remember one very real truism, war is inflationary.  It always has been, and it always will be.  Consider that every nation at war will spend as much as they can to produce and procure the weaponry they need to combat that war.  And they will borrow the money as that is the fastest way to move that process forward.  Second, scarcities will develop across an economy as inputs that would otherwise have gone toward ordinary consumer goods will be repurposed and commandeered toward the war effort.  The upshot is that demand will rise while supply will dimmish, a perfect recipe for inflation.

If we take that set of generalities and apply it to today’s situation, the starting point is already sticky high inflation with a massive debt load, at least in the US.  Elsewhere in the world, inflation appears to be starting to ebb, although the numbers remain well above the near-universal 2.0% target.  On the debt question, pretty much everybody has too much of that!  Of course, the situation in the US is the most important because it is the nation that is likely going to be financing a large proportion of any increase in hostilities despite the recent comments that the US will not take part in any Israeli retaliation.

Ultimately, though, even if we see a de-escalation of this situation, nations everywhere are going to be building up their war making capabilities given the overall level of uncertainty in the current world.  While Russia/Ukraine continues apace, and Israel is still fighting in Gaza, those are simply the issues that make the headlines.  Fighting continues throughout Africa (Nigeria, South Sudan Mali, Somalia, Congo) as well as in Iraq, Syria, Yemen and Pakistan.  This may be one of the least reported and most consistent drivers of global inflation that exists.  All I’m saying is that the combination of the current geopolitical situation and the still lingering effects from pandemic era policies has virtually ensured that inflation is not going to fall, at least not very far.  That means that haven assets and hard assets, often the same assets, remain high on the list of investments that are likely to perform well going forward.  Keep that in mind as you establish both your planning and your hedging.

With those cheery thoughts in mind, let’s see how markets have handled the next step up this escalator. Friday’s US equity market declines, which some have attributed to tax selling (today is Tax Day after all) was followed by weakness throughout most of Asia.  The exception was mainland China, which saw the CSI 300 rise 2.1%.  But elsewhere in the time zone, red was the color of the day, with Japan (-0.75%), HK (-0.75%), Australia (-0.5%), South Korea (-0.5%) and virtually every other regional equity market declining.  It seems that investors there are not so sanguine about a war in the Middle East.  

In Europe, though, as there is rising hope that things won’t get worse in the Middle East, equity markets are rebounding with most major indices higher by between 0.5% and 1.0%.  While that may be an optimistic reading of the situation, it is spreading as we have also seen early some gains in commodity prices back off.  The one exception here is the UK (-0.5%), but there is no obvious catalyst that is different for the outcome.  As I always say, sometimes markets are simply perverse.  Lastly, US futures markets are pointing higher as well, about 0.4% across the board at this hour (7:00).

Turning to the bond markets, it appears that inflation fears are greater than haven demand this morning. Treasury yields are higher by 5bps after a modest decline on Friday, while European sovereigns are seeing similar gains in yield, between 5bps and 7bps across the board.  While I understand the Treasury reaction given rising inflation expectations according to the Michigan Survey data released Friday, the European one is more confusing.  Even uber-hawk Robert Holtzmann agreed that a cut in June is likely, although future moves will be data dependent, and he is the most hawkish member of the ECB.  While inflation data throughout Europe has been declining, perhaps the bond markets are telling us they don’t believe that will continue.  Something doesn’t jibe with the recent comments and price action, and in that case, I always assume the pricing is correct.

In the commodity markets, oil (-0.8%) is lagging today as the ebbing fears of a wider Middle East conflict weigh on the black sticky stuff.  With that in mind, remember that oil prices are higher by nearly 4% over the past month, so this bull run does not appear dead yet.  However, metals remain in demand as we are seeing gains across gold (+0.7%), silver (+2.1%), copper (+1.2%) and aluminum (+2.1%).  I believe this story remains a combination of supply concerns as well as stories about excess demand from China, where copper stockpiles have been growing rapidly.  While it is not clear why they are buying copper, it is just one of several metals, notably gold, that China has been acquiring aggressively over the past months.  I maintain that this space has much further to run higher.

Finally, the dollar is under pressure this morning, although not universally so.  While the bulk of the G10 is modestly firmer, on the order of 0.2%, JPY (-0.5%) continues to suffer and is now pushing toward 154.00.  The last time USDJPY traded at this level was June 1990.  However, as long as the monetary policies between the US and Japan remain on divergent paths, the only thing that will stop this is concerted intervention, and the US seems unlikely to take part in such a move.  In the EMG bloc, the dollar is also on its back foot with MXN (+0.5%) the leading gainer and most of the rest of these currencies higher by much smaller amounts.  I would note CNY has rallied a touch after the PBOC withdrew CNY70 billion of liquidity as part of their money market operations today.  The Chinese are caught between the need for more stimulus to support the economy and the fear that more stimulus will lead to lower rates and capital flight, something which they have worked very hard to prevent.

On the data front, as exciting as last week was, this week should have some pretty good follow-ups.

TodayEmpire state Mfg Index-9.0
 Retail Sales0.3%
 -ex autos0.4%
 Business Inventories0.3%
TuesdayHousing Starts1.48M
 Building Permits1.514M
 IP0.4%
 Capacity Utilization78.5%
WednesdayFed’s Beige Book 
ThursdayInitial Claims214K
 Continuing Claims1820K
 Philly Fed0.8
 Existing Home Sales4.2M
 Leading Indicators-0.%

Source: tradingeconomics.com

As well as this, we hear from eleven more Fed speakers, including Chairman Powell tomorrow afternoon at the IMF spring meetings.  It will be quite interesting to hear how he handles the three consecutive hotter than expected CPI prints and whether there is going to be a subtle change in tone.  If he were to ignore it, I think that will be quite negative for bonds as it becomes a clearer indication that the 2% target is dead.

The thing about the 2% target is if the Fed abandons it, you can be sure that every other central bank will do the same.  That means that more rate cuts will be coming more quickly.  That, my friends, is a recipe for higher inflation, higher commodity prices and a much weaker bond market.  As to the dollar in that scenario, my take is it will still be the proverbial ‘cleanest shirt in the dirty laundry’ and will hold its own.

Good luck

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Smokin’

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The CPI data was smokin’
So, Jay and the doves are now chokin’
He’s lost the debates
And they can’t cut rates
Without, higher prices, provokin’

As such, it should be no surprise
That traders, risk assets, despise
So, bond yields exploded
While stocks all eroded
And dollars made new five-month highs

Welp, the inflation data was not merely a little hot, it was a lot hot.  Measured prices rose 0.4% on both the headline and ex food & energy readings for the month of March with the annual rises ticking higher to 3.5% and 3.8% respectively.  Too, you will not likely hear the inflation doves and those who had been concerned with deflation talking about the trend for the past 3 months or 6 months, as both of those are now running well above 4%.

In truth, if the Fed was both data dependent and actually still fighting inflation, rate hikes would be on the table again as there is absolutely no indication that either wages or rental/housing prices are heading back to the levels necessary to see an overall inflation rate of 2.0%.  Alas, it is also clear that politics is a part of the decision process and the concept of fiscal dominance, where fiscal policy overwhelms monetary policy, remains the order of the day.

Fed funds futures adjusted their probabilities instantly with the idea of a June cut now down to just 16% while there are less than 40bps of cuts now priced in for the rest of 2024.  Given this price action, it is no surprise that bond yields rose dramatically, with the 10-year closing the session at 4.54%, up 18bps and the highest close since November 2023.  My sense is it has further to go.  Meanwhile, 2-year yields rose back to 4.97%, a more than 21bp rise to levels also last seen in November 2023.  One other aspect of the bond market was the worst 10-year auction in more than a year as the tail was 3.1bps, the third largest tail in history, with a lousy bid-to-cover ratio (2.33) and much less foreign interest (61.4%) than we have been seeing lately.  The last 5bps of the yield rally came after the auction result.

Adding to the general gloom, equity prices fell about -1.0% across the board, but closed above their session lows.  It is the dollar, though that really saw a big move with a greater than 1% move against most of its major counterparts.  USDJPY blasted through the 152.00 level that many had thought was a line in the sand for the MOF/BOJ and is a full big figure higher.  Meanwhile, European currencies all declined by more than -1.0% and Aussie (-1.8%) was the absolute laggard across both G10 and EMG blocs.

With this as backdrop, the ECB sits down this morning and must decide if it is too early to cut interest rates.  The economic data continues to underwhelm, and the inflation data is actually trending lower, rather than the situation in the US where it has turned back higher.  But the sharp decline in the euro yesterday has got to be a warning to Lagarde and her minions as a cut, especially since it is not priced at all, would likely see another sharp euro decline, something they are certainly keen to avoid.

One other thing, the Minutes of the March FOMC meeting were released in the afternoon, and it seems the committee is coming to an agreement that they are going to slow the roll-off of Treasury securities, likely cutting it in half to $30 billion/month although they are not going to touch the mortgage-backed part of the balance sheet since that is barely declining at all.  It appears that this may take place at the June or July meeting, but clearly before too long.

Enough about yesterday.  Overnight saw Chinese CPI data fall back to -1.0% M/M, reversing the previous month’s rise, as it becomes ever clearer that China will never be able to consume as much as it is able to produce.  That is the very crux of the trade issues that are becoming more heated as China ultimately dumps all its excess production overseas, or at least tries to.  This is an issue that is not going to disappear anytime soon, and one that will have major political and economic ramifications going forward.  I suspect that the tariff situation will only get worse, and I would not be surprised to see further absolute restrictions on Chinese trade regardless of who wins the US election in November.  As to the market impacts of this story, for now, I believe Xi is more fearful of a capital flight if he allows the yuan to weaken substantially, than he is of annoying the US and the rest of the world because the yuan is too weak.  But, given the clear difference in the trajectories of the US and Chinese economies and inflation stories, pressure for yuan weakness is going to continue.

Turning to this morning’s session, Madame Lagarde and her crew meet, and the market is not pricing in any movement.  June remains the odds-on favorite for the first rate cut, and given the fact that the Eurozone, as a whole, is stagnant from an economic growth perspective, and that price pressures there have been ebbing more quickly, that certainly makes sense.  Of course, after yesterday’s CPI, June is off the table in the US so the ECB will have to act without the ‘protection’ of the Fed.  As mentioned above, the euro declined by more than -1.0% yesterday and is edging lower this morning as well, down -0.1%.  Lagarde’s risk is she follows the path of lower rates, the euro declines more sharply, perhaps to parity or beyond, and that invites a resurgence in imported inflation.  Remember, energy is still priced in USD, so that a weak euro would raise the price of oil products across the continent.  Alas for Madame Lagarde, it’s not clear her political nous will allow her to solve this problem.

Recapping markets overnight, following the US declines yesterday, the Nikkei (-0.35%) also fell, but I think the yen weakness helped mitigate the declines.  Chinese shares were lackluster, slipping slightly both in HK and on the mainland and the rest of the time zone saw a mix of modest gains and losses.  Meanwhile, European bourses are all in the red this morning, with Spain (-0.9%) the laggard, but the average decline probably around -0.5%.  US futures, too, are softer at this hour (7:00), down about -0.3% across the board.  Clearly, there is grave concern that the Fed is not going to help ease global monetary policies.

As further proof that US yields drive global bond markets, yesterday’s CPI data pushed European sovereign yields higher by about 10bps across the board!  This despite the fact that inflation is going in the other direction in Europe.  This morning, those yields are continuing to grind higher, up between 2bps and 4bps across the board.  However, Treasury yields have stalled after yesterday’s dramatic rise.  Let me say that if the PPI data released this morning is hot, I fear things could move much further.

In the commodity space, oil rallied yesterday on stories that Iran was preparing for a more substantial retaliation against Israel and despite the fact that EIA inventory data showed surprising builds in crude and products.  However, this morning it is edging lower, -0.5%.  Perhaps more interesting is gold (+0.2%) which is a touch higher this morning but was able to rebound off its worst levels of the session after the CPI print to close nearly unchanged on the day.  In the end, the market remains quite concerned about inflation regardless of the Fed’s response, and gold continues to get love on that basis.  As to the base metals, yesterday’s rate induced declines were cut in half, but this morning both Cu and Al are drifting lower by about -0.2%.

It is the dollar, though that had the most impressive movement yesterday and this morning, it is holding onto most of those gains.  Absent a hawkish message from the ECB this morning, something which I believe is highly unlikely, the euro feels like it has further to decline.  The BOC left policy on hold and sounded fairly non-committal regarding its first rate cut there.  The Loonie suffered yesterday and has seen no rebound at all.  In fact, the only currencies showing any life this morning are AUD and NZD, both higher by 0.25%, which seems much more of a trading reaction after their dramatic declines yesterday, than a fundamental story.  As long as the Fed remains the most hawkish, the dollar should hold its bid.

Turning to the data today, PPI (exp 0.3% M/M, 2.2% Y/Y) and core PPI (0.2%, 2.3%) lead alongside Initial (215K) and Continuing (1792K) Claims.  Those numbers will arrive 15 minutes after the ECB policy decision is announced with no movement expected there.  Madame Lagarde has her press conference at 8:45 this morning.  We hear from Williams, Collins and Bostic over the course of the day, so it will be quite interesting to find out how far their thinking has changed.  I would be particularly concerned if there is further talk of rate hikes again.  Remember, Bowman intimated that might occur when she spoke last week, and Bostic has been in the one-cut camp so could turn as well.  Let me just say the market is not pricing in that eventuality at all!

At the beginning of the year, I opined that there would be at most one rate cut and rates would be higher by Christmas.  As of this morning, I see no cuts and a very real chance of hikes.  Keep that in mind for its impact on all asset classes going forward.

Good luck
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Not Quite Mawkish

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On Friday, in quite the surprise
Our payrolls did massively rise
At least that’s what printed
But where those jobs minted?
Or will, next month’s data revise?
 
Perhaps Chairman Jay had a sense
And that’s why his press confer-ence
Was ever so hawkish
Although not quite mawkish
So, traders, more buys, did commence

 

I would contend that nobody was anticipating the NFP data on Friday which printed so much higher than forecasts it was remarkable.  A headline number of 353K with a revision up for December of 116K is huge and certainly puts paid to any thoughts of the economy slowing.  As well, Average Hourly Earnings rose a more than expected 0.6%, certainly good for workers, but another nail in the coffin of a quick rate cut by the Fed.  Of course, none of that seems to matter anymore to equity investors as despite every indication that given the recent data, the Fed will remain higher for longer, stocks rocked higher.  Bonds did not fare quite as well, though, as 10-year yields rocketed 15bps higher by the close.

Another interesting anomaly was in the Fed funds futures market where in the immediate wake of the FOMC meeting, the probability of a March rate cut (which you may recall Powell specifically took off the table) fell to 20% from a coin toss earlier.  But Friday, that closed back at 38%! (PS, this morning it is down to 15.5%, so remains quite volatile.)  Rounding out the asset classes, the dollar followed yields, with the euro falling nearly 1% and other currencies close behind.  As to oil, that slid about $1, but it has been softening all week, so there are obviously other issues there.  What gives?

The first thing to recall is that January data tends to be pretty sloppy.  My good friend, Mike Ashton (aka @inflation_guy) made the point eloquently as follows:

This is not to say that the adjustments WILL be huge, just that over time, that has been the case.  Recall that almost every reading last year was revised lower in subsequent reports.  All I’m saying is that as terrific as that number was, add at least a pinch of salt, I think.

The other thing that doesn’t seem to square is that so many other employment indicators are trending in the opposite direction.  After all, ADP was only 107K, and the employment reading in the ISM fell last month along with the employment readings in many of the regional Fed surveys.  As well, continuing claims have been trending higher for the past several months, generally not a good sign for employment.  Again, all I am trying to highlight is that this number may not be quite as robust as it seems on the surface.  At the same time, for the Fed, if they need an excuse to leave policy at current levels, the combination of strong job growth and rising wages is plenty of ammunition.

Sunday night, Chairman Powell was interviewed on 60 Minutes but really didn’t tell us anything new.  Essentially, I would say he repeated his Wednesday press conference with one exception, he did, when asked, indicate that the current fiscal profligacy would be a problem in the long run.  To date, he has been reluctant to even discuss the issue, so perhaps that is a signal of something, but of what I have no idea.

Moving on from Friday, finally, the weekend saw the Biden administration’s retaliation for the deaths in Jordan of 3 US soldiers, however, that is not a market impactful event.  Coming into the new week, the Services PMI data has been released everywhere and we are awaiting ISM Services this morning in NY.  In aggregate, the data showed that some nations are doing better than others.  In the positive camp, India (61.8 final) was by far the nation with the highest reading, but Japan, China, Spain, Italy and the UK all showed growth above 50.  On the other side of the ledger, Australia, Germany, France and the Eurozone overall remain well below 50, although seem to have found a bottom for now.  As to the US, the current forecast is for a 52.0 print, up from December’s number of 50.6.

Is this really telling us that much?  Remember, the question that is asked in these surveys is, how do things compare this month to last month?  Remember, too, that recent data has shown weakness across the surveys with strength in the hard data.  Friday’s NFP is the perfect encapsulation of that idea.  Perhaps the one thing we can consider is that if today’s ISM is quite strong, it will be enough to completely remove March from the rate cut schedule.  Of course, my question is, if today’s data is strong, why exactly will the Fed feel the need to cut rates at all?  I simply do not understand this baseline assumption that interest rates are “too high”.  In fact, based on the evidence provided by GDP and NFP data, they seem to be just fine.  And, hey, isn’t it better for all of us to earn 5% in our Money Market Fund accounts than 0.0% like we did for years?  In fact, based on the common view that there are several trillion dollars of “excess” savings in the economy, it seems the holders of those savings must be quite happy with rates where they are.

Ok, let’s tour overnight market behavior quickly before we finish up.  In the equity space, Japanese stocks continue to rise with the Nikkei up another 0.5% while Chinese stocks continue to struggle.  While the CSI 300 managed a 0.6% gain, the small-cap CSI 1000 fell 8% as small cap stocks around the world remain unloved.  However, the Chinese government is definitely concerned as rumors of another rescue package are all over the tape.  As to Europe, modest gains are the order of the day, with most markets higher by about 0.25%.  meanwhile, US futures, they are ever so slightly softer at this hour (7:15), down about -0.1%.

Turning to the bond market, apparently everybody is turning away from the bond market!  Yields are higher across the board with Treasuries leading the way, up a further 7bps, but all European sovereign yields higher by between 3bps and 5bps as well.  The story in Asia was even more impressive with JGB’s (+5bps) and Australia (+12bps) all catching up to the Treasury story.  Ultimately, the issue I see is that while growth in the US remains strong, pretty much all of Europe is in recession.  This seems likely to lead to the ECB cutting rates before the Fed as they will have a reason to do so, while as I ask above, what is the Fed’s rationale for a cut?

The higher interest rate story has weighed heavily on commodity prices with oil sliding -0.8% this morning, although it has been falling for a week.  But we see metals prices under pressure as well with gold (-0.6%), copper (-0.4%) and aluminum (-0.6%) all sliding this morning amid the move in yields.

Not surprisingly, the dollar has been a major beneficiary of the higher yield story, following Friday’s sharp rally with a continuation across the board.  The euro is back to 1.0750, a level not seen since mid-November, while USDJPY is back above 148.50 and USDCNY above 7.21.  In fact, the only currency bucking the trend today is KRW (+0.4%) which managed to rally despite any obvious macro catalysts.  Equities fell there alongside Chinese stocks, so it was not investment inflow.  Sometimes, currencies just move, that much we know.

Turning to the data this week, there is much less on the docket than we saw last week with, arguably, today’s Services ISM the most important number.

TodayISM Services52.0
WednesdayTrade Balance-$62.2B
 Consumer Credit$15.0B
ThursdayInitial Claims220K
 Continuing Claims1902K

Source: tradingeconomics.com

However, we do hear from 10 different Fed speakers this week starting with Atlant’s Raphael Bostic and then inundated rhoguhout the week.  But I ask you, will they really stray far from Powell’s message?  Especially after the blowout NFP number?  Higher for longer still lives, and if we continue to get strong data, May will soon start losing its appeal for a rate cut.  This will not help the bond market, that’s for sure, but it will help the dollar.

Good luck

Adf

News Not to Like

Posted on by 
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

Adf

Many More Pains

Posted on by 
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

Adf

Dim-Witted

Posted on by 
Said Jay, though we’re strongly committed
To make sure no ‘flation’s permitted
Quite frankly we’re lost
And ‘fraid of the cost
If we screw up cause we’re dim-witted

So, we’ll watch the data releases
And act if inflation increases
But if it should fall
Then it will forestall
More hiking lest we step in feces

As expected, the Powell comments were yesterday’s highlights as he once again explained that the goal of 2% inflation remains their primary effort.  Not surprisingly, given what we have heard from the onslaught of Fed speakers over the past two weeks, he made clear that there will be no rate hike at the November meeting, but December is still in play.  When asked about the rise in long-term yields, he did indicate it could be doing some of the Fed’s work for them, just like we heard earlier this week from Lorrie Logan and others.  Somewhat surprisingly, he mentioned the rising budget deficits, describing them as on an “unsustainable” path.  Now, we all know this is true, but Powell has been extremely careful not to discuss government funding throughout his tenure as Chair.  I suspect his next testimony to Congress could be a little spicier!

Of course, the other six speakers added exactly nothing to the conversation as they merely reiterated in their own words the same message.  Perhaps of more interest was that despite effective confirmation that there was no hike upcoming and that the bar for a December rate hike was quite high, bonds continued to sell off with the 10yr yield closing at 5.0% while stocks took it on the chin again.  Methinks there is more than a little concern starting to grow amongst asset managers that the concept of the Fed put may finally be gone.  

The other really interesting outcome yesterday was the fact that gold rallied another 1.3% despite the ongoing rise in interest rates.  As there was no new news out of the Middle East of any real note, one possible explanation is that investors are simply getting quite scared overall.  

One thing is quite certain and that is if the situation changes such that Powell and company become concerned that the economy is reversing course and they have, in fact, overtightened monetary policy, any reversal of the current message is likely to lead to some very big moves.  In that case I would expect a much weaker dollar, a huge rally in gold and other commodities, an initial rally in equities and, remarkably, not much movement in bonds.  I remain of the strong belief that the supply issue is the key bond market driver, so that will only increase in the event of an economic slowdown and that cannot help the bond market, even if the Fed starts to buy them again.  But that is all hypothetical.

Turning to the overnight session, while risk continues to be shed in Asia and Europe, we did see Japanese inflation data where the headline rate declined to 3.0% and the core to 2.8% although their super core reading is still at 4.2%.  Certainly, Ueda-san must be pleased that the numbers are beginning to edge a bit lower although they remain far above the 2% target.  Of course, the very fact that they are edging lower implies that any end to QQE is even further in the future.  Recall, Ueda-san has been clear that he does not believe 2% inflation is yet sustainable in the economy and is concerned it is going to slip back below that level in the medium term.  With that attitude, he has exactly zero incentive to end YCC or QQE and seems far more likely to continue with them.  

The implication of this outcome is that the yen seems likely to weaken further.  Currently, USDJPY is trading at 149.95 and although it hasn’t touched the 150 level since that first brush on October 3rd, it has been grinding ever so slowly back there again.  This price action has all the earmarks of stealth intervention, something that may be carried out by the three Japanese mega banks at the BOJ’s behest.  However, given the ongoing trajectory in US interest rates, it seems only a matter of time before we once again breech 150.  It will be quite interesting to see the MOF/BOJ reaction at that time, although I suspect they will, at the very least, “check rates.”  For hedgers, be careful here.

And really, that’s all we’ve got to talk about today.  As mentioned above, equity markets fell in Asia overnight, with losses on the order of -0.5% or so and European bourses are all down about -1.0% this morning heading into the US open.  As to US futures, at this hour (7:00) they are off about -0.4% as we head into an option expiration session.  Thus far, earnings season has not been sufficient to excite investors and fear seems to be the driver of note.

Turning to the bond market, while we have backed off from yesterday’s closing highs of 5.0% by 5bps, we remain at multi-year highs and there is no reason to believe that we have seen the top in yields.  In fact, this move appears to be driven by rising real yields, not inflation concerns.  While real yields have already risen substantially over the past 6 months, rising from ~1.0% to the current 2.45%, history has shown that real yields can easily rise to 4% or more in the right circumstances, and these may just be those circumstance.  Again, there is no evidence that Treasury yields have topped.  As to European sovereigns this morning, they are edging lower by about -1bp after a large rally yesterday as well.  US Treasury price action continues to be the global driver for now.

Oil prices (+1.5%) continue to trade higher as concerns over a widening of the Israeli-Palestinian conflict keep traders on edge.  Combine this with the weaker production numbers from the US and the drawdown in inventories and you have the ingredients for a further price rally.  News that a US Missile Cruiser in the Red Sea shot down several drones and missiles launched from Yemen cannot have helped sentiment.  Meanwhile, gold (+0.4%, +2.6% this week) continues to play the role of safe haven.  Either that or there is a lot of short-covering ongoing.  The price is approaching $2000/oz, one of those big round numbers on which markets tend to focus so I would look for a test there if nothing else.  However, base metals are softer this morning as the price action today is not economically related.

Finally, the dollar continues to tread water this morning with most of the major currencies within +/- 0.2% of yesterday’s closing levels while EMG currencies seem to be edging a bit lower, down on the order of -0.3%.  The renminbi is little changed this morning despite (because of?) the PBOC injecting CNY733 billions of fresh liquidity into the market/economy there overnight.  Again, just like the yen, the diametrically opposed monetary policy of China and the US should lead to further currency weakness here over time.  Now, the PBOC doesn’t like to see sharp movement and will continue to prevent a blowout move, but the spot rate is currently trading right at its 2% band vs. the CFETS fixing, so something has got to give soon.  In the end, the dollar trend remains intact, but I must admit I am surprised it is not a bit stronger given the underlying fear in the market.

On the data front, there are no statistics released and we hear from two more Fed speakers, Harker and Mester, to finish things off before the quiet period begins.  It seems hard to believe that anything they say will be seen as more important than Powell’s comments yesterday.  As such, looking at today’s market activity, while there will be tape-watching regarding the Middle East and any escalation in hostilities, I suspect the equity market will have the most influence on things.  At this point, further weakness seems the most likely outcome, especially as traders will be reluctant to be overly long risk heading into the weekend.  

Good luck and good weekend

Adf

Five Percent

Posted on by 
The number one story today
Is that 10-year bond yields soon may
Trade to five percent
As bond bulls lament
Their theory’s no longer in play

As I write this morning at 6:45, 10-year Treasury yields are now trading at 4.95% having touched 4.98% a few hours ago.  This has become the biggest story of the day given the psychological impact of yields rising to that level and the fact 5.00% is such a big round number.  There is a lot of sentiment regarding round numbers in markets, so things like parity in EURUSD or $100/bbl in oil or even stock indices (e.g., S&P at 4000) take on a life of their own whether or not there is any fundamental driver of a particular situation.  But let’s face it, the market is all about psychology, so if people care, it matters. 

If (when) we trade through 5.00% will anything have changed?  Unlikely, but it is definitely today’s narrative.  It appears that the drivers are anticipation of yet more supply next week as well as continued confirmation that the Fed is going to maintain Fed funds at current levels for quite a while, even if there are no more rate hikes.  We also continue to hear stories of selling by major holders although I addressed that yesterday.  Certainly, part of the market zeitgeist is the idea that the continued strong US economic data are the seeds for ongoing inflation pressures leading to higher yields.  But in the end, the only thing of which we are sure is that demand for paper, despite the highest yields in more than sixteen years, is underwhelming.  At least relative to the supply of paper that is available and due to come soon.

For now, I expect that as yields continue to climb, we are going to see ongoing struggles in the equity market, dollar strength and commodity prices struggling.  Of course, gold continues to buck that trend as it is holding up extremely well in the face of higher yields. 

In the meantime, it is worth remembering the Fed stance, which clearly still matters.  

Said Waller, we’ll “wait, watch and see”
How things in the broad ‘conomy
Evolve before moving
And if they’re improving
More rate hikes will be the decree

Said Williams, the time’s not arrived
To alter the rates we’ve contrived
Though, progress we’ve made
We’re still quite afraid
That falling inflation’s short-lived

It is becoming abundantly clear from the comments by all the Fed speakers during the past two weeks that there will be no policy rate movement at the next meeting.  Of course, Chairman Powell has yet to offer his views, which are due today at noon.  However, it seems difficult to believe that this overwhelming agreement of a pause to, as Governor Waller put it, “wait, watch and see,” the evolution of the economy has not been approved by the Chairman.  Nonetheless, you can be sure that his words will be parsed especially carefully later today.

Of course, the data continues to show that the economy is not slowing down in any substantive fashion and the bond vigilantes are out in force.  After yesterday’s 8bp yield rally above 4.90%, this morning’s movement should be no surprise.  We also saw European sovereign yields explode higher yesterday with UK Gilts up 15bps and continental bonds up between 5bps and 10bps.  As I have been consistently writing, this move is nowhere near over.  One other thing that has not yet garnered much attention is that the Bund-BTP spread is now at 206bps after the Italian government just passed a financing bill that includes a 4.2% government deficit, well above the 3.0% EU limit and above the promises made when PM Meloni first entered office.  Concerns are growing that Italian finances may soon become a real problem, not just for Italy, but for Europe as a whole.

We should also discuss the JGB market where the 10-year yield is now at 0.85%, creeping ever closer to their new alleged line in the sand at 1.00%.  Recall, the BOJ is the only major central bank that is explicitly buying bonds and has promised to buy an unlimited amount to prevent yields from rising above that 1.00% level. In fact, 1.00% JGB yields is the only round number that has any true significance.

Ultimately, the current interest rate / yield story is the key driver across all markets.  In addition to the dramatic movement we have seen in bond markets, yesterday saw pronounced weakness in equity markets and strength in the dollar.  After falling more than -1.0% here, Asian markets fell even more sharply, between -1.5% and -2.0%.  European bourses are also under pressure this morning, but not quite to the same extent as they suffered somewhat yesterday in their afternoon sessions.  As to US futures, they are unchanged at this hour (7:15) awaiting Powell’s comments.

Oil prices (-1.25%) are backing off a bit from their recent rally after news that the administration has relaxed sanctions on Venezuela indicating that there will be a bit more supply available.  However, yesterday’s inventory data showed significant drawdowns and cannot be ignored as a fundamental driver which would imply higher prices going forward.  Gold, after another spike yesterday of more than 1% is creeping still higher this morning with the best explanation a growing concern over a much more uncertain future.  After all, if investors are losing their faith in Treasury bonds, and as evidenced by the ongoing selling pressure, that is one possible explanation, gold has always served as the ultimate safe haven.  As to the base metals, they are also firmer this morning, arguably on the back of still surprisingly strong US economic data.

Finally, the dollar is mixed this morning, with gains vs. the pound and the commodity bloc while the euro has managed to edge higher.  USDJPY remains stuck just below the 150 level as though someone is working very hard to prevent that level from trading again.  In fact, we have traded between 149.40 and 149.85 for the past week, an extremely tight range that looks quite artificial.  Do not be surprised if we finally breech the 150 level for a time and then see another bout of intervention by the MOF/BOJ driving it back down again.  Ultimately, though, if the BOJ maintains its current stance, the yen is going to trend weaker.  

A quick look at the EMG bloc shows that CNY is trading to its weakest point in more than a month as news that Country Garden, the erstwhile largest property developer in China, failed to make a coupon payment yesterday for the second time and is set to file for bankruptcy has raised concerns over the entire economic process there.  Elsewhere, IDR (-0.5%) fell during its session although I would expect some strength tonight as the central bank there surprised the market and raised their base rate by 25bps after the market closed.  In general, the EMG bloc has seen weakness across the board with the dollar ‘wrecking ball’ wreaking havoc for those companies and countries that need to service their USD debt.

On the data front we see Initial (exp 212K) and Continuing (1710K) Claims as well as the Philly Fed (-6.4) and then Existing Home Sales (3.89M).  In addition to Chairman Powell, we hear from six other Fed speakers, although with Powell speaking and the second in the lineup, I don’t imagine the other comments will matter much.  Remember, after tomorrow, the Fed enters its quiet period as well.

Looking at the totality of the situation, it would be shocking if Powell added anything new to the debate.  At this point, I expect that the bond market will remain the driver of everything.  I also expect that 10-year yields above 5.00% are coming soon to a screen near you and that the normalization of the yield curve will be completed before the end of the year.  Right now, the 2yr-10yr spread is down to -28bps and an eventual move to +50bps – +100bps would put us back in ‘normal’ territory.  In other words, 10-year yields could rise much further!  In that situation, I still like the dollar overall.  I will need to see something substantial change before the dollar’s bullish trend turns around.

Good luck

Adf

Growth Dynamo

Posted on by 
The data continues to show
Economies still want to grow
Here in the US
The Retail success
Came ere China's growth dynamo

The upshot is all of the talk
That bonds are where people should flock
Turns out to be wrong
Then those who went long
Are likely to soon be in shock

Wow!  That’s all you can say about the data from yesterday where Retail Sales were hot and beat on every measure (headline 0.7%, ex-autos 0.6%, control group 0.6%) while IP (0.3%) and Capacity Utilization (79.7%) also indicated that economic activity remains quite robust in the US.  On the data front, this was followed by last night’s Chinese data dump where every one of their monthly indicators; GDP (4.9%), IP (4.5%), Retail Sales (5.5%), Fixed Asset Investment (3.1%), Capacity Utilization (75.6%) and Unemployment (5.0%), was better than expected.

Perhaps the idea that a recession is right around the corner needs to be reconsidered.  And remember, I have been in that camp as well, but the data is the data and needs to inform our opinions.  The immediate reaction to yesterday’s US data was a sharp decline in both stocks and bonds, while oil rallied, gold edged higher and the dollar tread water.  Of this movement, I was most surprised at the dollar’s lack of dynamism given the rate situation.  Unremarkably, given the ongoing belief in the Fed pivot, by the end of the day, US equities were tantamount to unchanged.  But the bond market remains under severe pressure with yields having risen another 12bps in the 10-year and having now reversed the entire safe haven move on the back of the Israeli-Hamas war situation.  

I continue to believe that yields have much further to rise and stronger data will only add to the case.  My view had been based on the combination of stickier inflation than the punditry describes along with massive amounts of new issuance requiring a lower price (higher yield) to clear markets.  But if we are going to continue to see strong economic growth, then there is an added catalyst for yields to rise.

One of the problems about which we hear constantly these days is the fact that there are no more natural buyers of US Treasury debt, at least not at current yield levels.  Many point to the decline in ownership by both Japan and China, the two largest foreign holders of Treasuries, and claim they are both selling their holdings.  However, I have a quibble with that thesis and would contend that perhaps, they are merely suffering the same mark-to-market losses that the banks are.  For instance, according to the US Treasury Department, holdings by these two nations from July 2022 through July 2023 declined by -9.6% (Japan) and -12.5% (China) respectively as can be seen in the chart below.  (data source US Treasury)

But ask yourself what has happened to interest rates over the past year?  They have risen dramatically (10yr yields +85bps) and that means the price of bonds has declined.  As a proxy, in the past 12 months, TLT (the long bond ETF) has declined by more than 13% in price.  So, if you have the exact same amount of bonds and their prices declined by 13%, it is not hard to understand how when you measure the value of your portfolio it has shrunk by upwards of 13%.  I have no idea what the maturity ladders for Japan and China look like, and it is likely they own a mix of short and long-dated bonds, but it is not at all clear to me they have actually been selling Treasuries.  Likely, they are simply holding tight, and I would not be surprised, given the dramatic rise in yields here, if they roll maturities into new bonds.  All I’m saying here is that the narrative about everybody fleeing bonds may not be correct.  In fact, regarding the TLT, which is a pretty good proxy for bond demand of the retail investor, there is a case to be made that demand is quite high.  My understanding is that calls on the TLT are amongst the most active contracts in the options market, and people don’t buy calls if they are bearish!

With that in mind, though, the underlying point is US yields continue to rise and that is going to be the driver for all markets.  In global bond markets, the US unambiguously leads the way and we have seen European sovereigns show similar movement to the US with large moves higher in yields yesterday, on the order of 10bps – 15bps depending on the nation, and consolidation today with virtually no movement, the same as Treasuries.  Last night, JGB yields managed to rally 3bps as well, another indication that as goes the US, so goes the world.

But the more interesting thing to me is the ability of the equity market to hold onto its gains.  The fact that US markets rallied back nearly one full percent from the immediate post-data lows was quite impressive.  Consider that the leadership of the US stock market has been the so-called magnificent 7 tech stocks (Apple, Microsoft, Google, Amazon, Nvidia, Meta (nee Facebook), and Tesla) most of which are essentially long duration assets with their extreme values based on a belief that they will continue to grow at incredible rates.  But with yields rising, the present value of those anticipated earnings continues to decline which should generally be a negative for their price.  So far, they have held up reasonably well, but cracks are definitely starting to show.  I suspect that at some point in the not-too-distant future if yields continue on their current trajectory, that equity market comeuppance will arrive and these stocks will feel the brunt of it.  But not yet apparently.  Interestingly, despite the positive Chinese data, equities in Hong Kong and the mainland both declined about -0.5%.  And looking at Europe, weakness is the theme with all the major bourses lower by -0.5%.  As to US futures, -0.25% covers the situation at this hour (8:00).

Meanwhile, the escalation in Israel and concerns about a wider Mideast war have joined with the stronger economic data, especially from China, to push oil prices higher again this morning, up 1.8%.  And that war theme has gold rocking as well, up 1.3% to new highs for the move with both copper and aluminum rising on the better economic data.  High nominal growth and high inflation (so low real growth) is going to be a powerful support for commodity prices.

Finally, turning to the dollar, this is where I lose my train of thought.  Given the higher yields and seeming increased worries about a wider Mideast war, I would have expected the dollar to continue to rally.  But that has not been the case.  Instead, it has been stable, stuck in a tight range against most of its major and emerging market counterparts.  Perhaps this market is waiting to hear from Chairman Powell tomorrow before traders take a view, but I need to keep looking for a reason to sell the dollar as the evidence to buy it seems strong, higher yields and safety.

Today’s data brings Housing Starts (exp 1.38M) and Building Permits (1.45M) as well as the EIA oil inventory data.  We also hear from a bunch more Fed speakers; Waller, Williams, Bowman Harker and Cook, so it will be interesting to see if there are more definitive views on a pause, especially after the recent hot data.  I have not changed my view that the dollar has further to rise, but its recent relative weakness is a potential warning that something else is driving things.  I will continue to investigate, but for now, higher still seems the better bet.

Good luck

Adf