Tag Archives: #inflation

What’s Next To Be Feared?

Posted on by 
For Holmes, when the dog didn’t bark
He recognized that was the spark
To solving the case
And so, we must brace
For narrative changes quite stark

This morning, no headline appeared
Regarding Iran, which is weird
Have markets moved past
This problem, at last?
And if so, what’s next to be feared?

So, perusing the WSJ on-line this morning, the notable absence was any story on Iran and the current situation regarding the ongoing peace talks.  There was a throwaway article about Trump and what he has said about Iran, but nothing of substance.  Part of me is amazed that this is the case as the conflict would still seem to be the most important issue in the markets given the impact on oil prices and inflation, as well as its general geopolitical impact.  But part of me cannot be surprised at all.  It’s not just traders who have the attention span of a fruit fly, apparently so does the general public.

I made the point several weeks ago that this conflict would fade into history quickly when it was ending based on the fact that the Venezuela incursion, back in January, fell from headlines within about three days.  Given the generic MO for most publications of, if it bleeds, it leads, the fact that bombs are no longer falling, and peace talks are ongoing is no longer that interesting.  Add to that the generic TDS of most of the media, where they loved to play up rising oil prices as a major policy failure for Trump, now that those prices have been falling for the past 11 weeks and have slipped >30% in that period, and quite frankly, have further to fall, most editors have moved on.  If they cannot tar Trump with a policy failure, they would rather not discuss the subject at all.

Source: tradingeconomics.com

So, here we are this morning with the market now turning its focus to an ostensibly hawkish Fed despite the recent analysis by the BLS indicating that more than 60% of the recent uptick in inflation was driven by the rise in energy costs.  So, with energy costs reversing course dramatically, what does that say about their impact on inflation and exactly how hawkish does the Fed need to be in that case.

Right now, equity markets are under some pressure as some of the euphoria associated with the rising tech sector’s stock prices and the ongoing AI mania, is wearing a little thin.  And let’s face it, things certainly seemed a bit bubblicious.  But the combination of ongoing fiscal support from the OBBB and tax cuts and declining energy prices is likely to help support things going forward.  No matter the timeline you observe, we have seen a remarkable rally in tech stocks, as evidenced by the NASDAQ’s chart below.  A correction to the 50-day moving average would hardly be surprising, nor would it be damaging to the overall market structure, I think, although it would almost certainly result in ‘end of days’ headlines!

Source: tradingeconomics.com

So, while futures this morning are lower across the board (NASDAQ -2.9%, SPX -1.4%, DJIA -0.6%) as of 6:40am, and we could easily see some weakness for a few more days/weeks as positions shake out, I am not in the camp of things are about to collapse.

Speaking of equity markets, the overnight session was filled with red ink led by the KOSPI (-10.0%) in South Korea, although there was weakness pretty much everywhere (Nikkei -3.6%, CSI 300 -2.8%, Hang Seng -1.8%) with India and Taiwan also slipping more than -1.0% although Australia, NZ and Singapore had more muted declines.  Tech was clearly under pressure.  Of course, we cannot be surprised that European shares are also lower in a generally weak risk scenario, but given the lack of tech companies headquartered there, the declines have been far less significant (DAX -1.0%, CAC -0.6%, IBEX -0.2%, FTSE 100 -0.2%) although the Netherlands (-1.3%) home to ASML, the only tech name of note on the continent, is underperforming as well.

Meanwhile, the bond market has peeked at the oil market and decided, perhaps inflation is not a chronic condition, or at least not as bad as previously feared.  Yields are lower across the board with Treasuries (-3bps) leading the way while European sovereigns are all lower by between -3bps and -4bps.  Overnight, though, JGB yields could make no headway lower as the yen continues to be under enormous pressure.

Speaking of the yen, it continues to slowly weaken despite prominent statements by Japanese FinMin Katayama about her discussions with Treasury Secretary Bessent and their agreement to have the US coordinate with Japan in the event it is decided something needs to be done in the markets.  But so far, no signs of actual intervention.  A look at the chart below shows a very slow and steady climb in the dollar, and frankly, I do not see what will change this trajectory.

Source: tradingeconomics.com

While interest rates aren’t the only driver, they still have a key impact, and they are the one thing that can be changed quickly.  In fact, the best hope for the yen, in my view, is the fact that at some point soon, the market is going to understand the Fed is not about to raise rates again, and the next move will likely be lower, albeit not until later in the year.  but that change in tone will change a lot of opinions on how the yen should behave, and a move back toward 155 amid modest overall dollar weakness could easily be seen.  But right now, everybody is of the opinion that the FOMC is going to hike this year, and Japan cannot afford to be aggressive in that context, hence the yen’s weakness.

Here is a forecast I do not make lightly, Fed funds will finish the year lower than they are now, probably 3.25%-3.50%.  And the current Fed funds futures market has bottomed (rates peaked) as per the CME table below.

As to the rest of the FX world, the dollar reigns supreme this morning as the euro (-0.3%) is below 1.1400 this morning, its weakest in more than a year as the Flash PMI data did it no favors, but the new hawkish Fed, higher US rates strong dollar narrative has been the driver.  We have seen the same type of movement elsewhere, except where the dollar has moved further, with AUD (-0.8%) the worst performer in the G10 although HUF (-1.0%) is actually the biggest laggard.  However, given the overall decline in commodity prices, those currencies that benefit from rising commodities are also under pressure (NOK (-0.7%, ZAR -0.5%, SEK -0.8%, MXN -0.7%) and we already discussed AUD.

Lastly, the metals markets are also under serious pressure with gold (-1.6%), silver (-4.5%) and copper (-3.3%) all tumbling on the same new view of higher rates and a stronger dollar.  The thing about the commodities story is the fundamentals still seem positive to my eyes, and this seems like the last of the fluff getting taken out.

On the data front, Thursday’s PCE data is the big day and here’s what we have overall:

TodayFlash Manufacturing PMI54.8
 Flash Services PMI51.0
WednesdayNew Home Sales640K
ThursdayInitial Claims225K
 Continuing Claims1800K
 Q1 GDP Final1.6%
 Personal Income0.4%
 Personal Spending0.6%
 PCE0.5% (4.0% Y/Y)
 Core PCE0.3% (3.4% Y/Y)
 Durable Goods-4.3%
 -ex Transport0.7%
FridayMichigan Sentiment50.3

Source: tradingeconomics.com

In addition to the data, we start to hear from some of the FOMC members, although I am confident Chairman Warsh won’t be out and about.  Some analysts claim that Warsh’s view of less communication is going to weaken him as others will get to make their point and he won’t be able to counter it.  But I think that Warsh has a plan, and if we continue to see oil prices decline, which seems the likely outcome, then all the inflation fears are going to dissipate and by the time the next meeting rolls around, it will be far harder to make the case that tighter policy is necessary.  Historically, hiking into an energy price shock has been a central banking mistake, and I think Warsh knows this and is keen not to repeat it.

Net, for now, everybody loves the dollar and hates risk on this new hawkish Fed narrative.  But going forward, I like the dollar on the back of a better economy and better investments and expect that the hawkish Fed narrative is going to fade away.  But I’m just an FX poet.

Good luck

Adf

My House

Posted on by 
Said Kevin, the Fed’s now MY house
And views that we choose to espouse
Will no longer guide
So, when we decide
To move, we expect some to grouse

As well, we are set to review
Our policies all the way through
So, comms will be changed
And data arranged
In truth, it is quite the to-do

This is an evening note as I will be unavailable to write tomorrow morning as we head off to show GCH Nubia’s Take Your Breath Away, aka Marvel to a show.  That is his handler and the judge who awarded him Best of Breed that day.

But not surprisingly, the only thing that really mattered today was the FOMC meeting.  I have to say, having watched the entire press conference I am really impressed with Chairman Warsh.  I love the fact that he shortened the statement and that they are ending forward guidance.  And it was quite interesting that half the reporters’ questions were trying to get guidance about what the Fed may do in the future, despite him repeating that there was no more forward guidance.  My take is Fed reporters are going to have to learn about how markets work and more importantly, market practitioners are going to make up their own minds rather than rely on the Fed to bail them out.  This is all really positive!

The most noteworthy thing was the creation of five task forces to address issues with the way the Fed currently does things on the following subjects:

  1. Communications
  2. Balance Sheet
  3. Data Sources
  4. Productivity and Jobs
  5. Inflation Framework

So, it strikes me that Chairman Warsh is going to look to reprogram the Fed, something that has been sorely in need.  Do not be surprised when much of the commentary is negative on these subjects because those are the folks who benefitted from the old way of doing things.  They now need to change their models and their narratives and they are unhappy.  Another benefit.

The upshot of the meeting was that rates were left on hold and the dot plot, where Warsh did not supply a dot, showed that half the committee thought rates appropriate, and half thought they would be higher by the end of the year.

Of course, this largely jibes with the Fed funds futures market as you can see in the latest table from the CME.

Of course, looking at this table, something seems amiss for September, perhaps there was a large position put in place that drove the market.  At any rate stock markets were unhappy with the major indices slipping -1.0% or more after the FOMC although bonds did very little and commodities continue to show oil slipping while gold and silver rise.  As to the dollar, it rallied pretty much across the board.

It is way too early to anticipate exactly how things are going to play out, but I am encouraged.  I strongly believe a little price volatility is a small price to pay to reduce systemic risk by reducing leverage in the system, and that is very likely to be the outcome if Mr Warsh has his way.  My forecast is the “ample reserves” balance sheet program is going to change before he is done.  If that is the case, I think they will have a real opportunity to get inflation under control.  As well, I believe that prospect will undermine much of the ‘death of the dollar’ narrative.  It truly will be significant.  We shall see.

Good luck

Adf

Future With Dread

Posted on by 
The story today is the Fed
And whether, when looking ahead
Inflation they see
Stays well above three
Or if it just might fall instead

Meanwhile, every comment I’ve read
Discussing the ‘deal’ have all said
Too much was conceded
The US retreated
And look to the future with dread

Starting with the MOU with Iran, and having read the text of the agreement, at least the one published by Bloomberg, Iran has sworn to never have a nuclear weapon and then will effectively be readmitted to polite society, with sanctions and restrictions eventually removed.  The several comments I have read on the deal highlight numerous potential loopholes and semantics regarding tolls and fees and are uniformly unhappy with the deal.  But I’ve also read that many on Iran’s side are unhappy with the deal.  Arguably, the best sign the deal is going to last is just that, neither side got everything they wanted, but both got some of the things they wanted.  Time will tell how this all plays out, but certainly the oil market remains positive that the direction of travel is toward a normalization of flows through the Strait of Hormuz.

However, while the political pundits are going to continue to focus on that issue, markets have turned their focus to the FOMC meeting and how things play out under new Chairman Kevin Warsh.  The previous Fed whisperer, Nick Timiraos at the WSJ, continues to push Governor Powell’s message as there is not yet a new Fed whisperer.  My take is Timiraos will not be the one simply because his loyalties will not lie with Warsh. 

The thing in which we can be most confident is there will be no rate change at today’s meeting although the market continues to price a rate hike in December as per the below CME table.

All the drama will come with the release of the SEP (Summary of Economic Projections) which is the quarterly document the Fed publishes showing the range of economic forecasts by the individual FOMC members regarding GDP, Unemployment and interest rates.  This document also includes the dot plot.  It is important to note that the SEP only started to be released in 2007, so this is not a long-standing tradition, but part of Ben Bernanke’s changes to the institution.

And this is a key feature of what makes Kevin Warsh different.  He has indicated that the Fed talks too much (I agree) and believes that some ambiguity in what is going on is a desired outcome.  This is a controversial stance as Wall Street has minted money on the back of forward guidance, recognizing the Fed has their back whenever they blow up because they built up huge leverage and were wrong.  

While I completely understand the idea that political discussions need to be in the open, I am far more suspect with respect to monetary policy discussions.  Prior to forward guidance, market participants were far more cautious in their positioning as the probability of getting the direction of a trade wrong was far greater.  But once the Fed says, ‘rates are going to stay low for a very long time’, traders can lever up positions massively relying on the fact that their funding costs are going to remain in check.  And it is the massive leverage where the risks to the market lie, not the level of rates per se.

So, the question today is how Chairman Warsh will handle his desire to reduce communications compared to the previous actions of publishing the data and numerous FOMC members speeches.  One thought is he may refuse to put his own forecasts into the document, a sign of what he wants going forward but I am confident he has other ways to move forward.

The other issue is the question of the tone of the statement, which had ostensibly been leaning dovish but seems now likely to be neutral.  My sense is whatever he does, it will be incremental, at least at the beginning, but I anticipate that he is going to make substantial changes to the way the FOMC operates during his tenure as that is why he was put in the role. 

So, with that as our backdrop, let’s see how markets have absorbed the text of the deal as we all await the FOMC this afternoon.  Yesterday’s mixed US performance, with only the DJIA managing a gain while tech stocks dragged down both the NASDAQ and the S&P, was followed by more positivity than not in Asia with gains in Japan (+0.7%), China (+1.0%), Korea (+1.6%) and India (+0.5%) while HK (-0.75%) slipped a bit.  It is always a bit of a surprise when HK and China move in opposite directions, and it seems today’s split arose from different interpretations from a policy conference regarding future PBOC activities as well as potential future government support for a clearly weakening consumer economy.  Other regional exchanges had a mix of gainers and laggards as well, as the overall session was directionless.

In Europe, the picture is also mixed although the movement has been more muted than those in Asia.  Both Germany and the UK are flat to slightly lower this morning with the former under pressure after BMW offered a terrible profit forecast while the latter, despite lower-than-expected inflation readings, is lagging on growth concerns.  However, France (+0.2%) and Spain (+0.5%) have both managed to rally a bit on some slightly positive earnings news.  As to US futures, at this hour (7:15), they are modestly higher across the board.

Bond yields are generally little changed this morning with only UK gilts (-5bps) and JGBs (-4bps) showing any movement at all.  Gilts responded positively to the inflation data while JGBs seemed to take solace in the trade data showing Japan was back to a deficit.  

In the commodity markets, oil (+0.7%) is having a very quiet session after several sharp declines in a row while metals markets are largely unchanged this morning.  It appears even traders here are awaiting the FOMC outcome.  One thing I have seen is a recent report from the World Gold Council showing 45% of central banks surveyed plan to buy the barbarous relic in the next 12 months.

And finally, the dollar is slightly stronger this morning, but like most other markets, not showing much movement at all.  The below chart of the DXY for the past month shows just how lackluster price action has been with a total range of just 1.5%.  The red line is the midpoint of that range showing there is just not a lot of pressure in either direction right now.

Source: tradingeconomics.com

Meanwhile, USDJPY has basically spent the past two weeks hovering just above 160.00 with nary a peep from the MOF or BOJ.  Again, the situation there is the policy changes necessary to strengthen the yen are likely to have very negative economic consequences initially, and that is not something any government is likely to do.

On the data front, ahead of the Fed we see Retail Sales (exp +0.5%, +0.5% ex-autos) and then the EIA oil inventories with more draws expected.  And that’s really all there is.  I anticipate a very quiet session ahead of the Fed and then all will depend on how the market interprets Warsh’s signals.

Good luck

Adf

Many Malign

Posted on by 
Said Trump, come next Friday I’ll sign
A deal, and though many malign
The war with Iran
It’s all gone to plan
As they’ve lost their arms and their spine

Thus, oil has fallen in price
While gold and stocks rose in a trice
With bears in retreat
For Trump’s next great feat
Some midterm success would be nice

This is a look at the major energy futures markets according to tradingeconomics.com at 5:15 this morning

Sharp declines on the session in the wake of the announcement, confirmed by the Iranians, that a deal had been struck and that the Strait of Hormuz would be reopening by Friday after the mines are cleared.  And while there has been much discussion over the past week, as you can see in the far-right column, energy prices are still largely higher year-to-date with only NatGas the exception.

To my mind, the question becomes, just how quickly prices continue to decline, and can gasoline prices, the one that matters most to the US consumer, slide back to the $2.00/gallon level that we saw prior to the war?

As you can see from that chart below, it still has a long way to fall, but if the Strait remains open, I suspect it will round trip by the end of the summer, just in time for people to start considering their voting habits.

Source: tradingeconomics.com

Remember this, as well, how much have you heard about Venezuela lately?  Back in January, less than six months ago, the US captured and remanded Nicholas Maduro into custody and the world was up in arms.  I would wager that most people don’t even remember it happened!  Memories are very short for global events like this (consider the fact that the Russia – Ukraine war continues and it never even makes the proverbial papers anymore).  For President Trump, the outcome of this situation will be a massively degraded Iranian military with pretty much the rest of the GCC aligned against everything they stood for, an economy that continues to demonstrate remarkable resilience, high stock prices and the likelihood that inflation, as oil prices slide, will be heading back closer to the theoretical 2% target.

There once was a time central banks
Were saviors, and we would give thanks
For all of their aid
When, problems, they slayed
And bankers, they all would close ranks

But last week the ECB raised
Tonight, Ueda-san will be praised
For hiking rates too
So, what will Warsh do?
On Wednesday when his trail is blazed?


Meanwhile, we are in the midst of the monthly central bank onslaught as last week, Madame Lagarde and the ECB raised their base rate by 25 basis points, blaming the ongoing rise in oil prices for leading to inflation.  Of course, 96 hours later, with the announcement by both sides of a deal to end the Iran conflict, this is likely to be seen as an error, the full Trichet as it were.

Tonight, the BOJ meets and all signs are that they, too, are going to be hiking rates by 25bps tonight, to 1.00%, which you will have heard is the highest in more than 30 years.  It’s funny, the official inflation data from Japan is showing a reading of 1.4%, below their target, and now that the prospect of oil prices falling more sharply has increased, it feels like they may be on the cusp of an error here as well.  Consider that of all the governments around, the Japanese with a debt/GDP ratio of about 250% is the nation least able to absorb higher interest rates.  

Which takes us to Wednesday’s FOMC meeting, the first under Chairman Warsh.  There is a long Nick Timiraos article this morning in the WSJ ostensibly explaining that Warsh would like to see less Fed communication, including killing the dot plot, and have the cacophony of Fed speakers shut up.  First, Timiraos has real skin in this game because while he was Powell’s go to, I doubt he will be Warsh’s, thus Timiraos’s status is about to be hit hard.  In fact, the article read as though Powell was writing it to make it seem as though Warsh’s ideas are all wrong.

Personally, I am in favor of less communication by the Fed as policy uncertainty will result in significantly reduced positioning in the speculative community and that is a net benefit for the rest of the market.  Plus, if there is a hiccup, there is less reason for a bailout.  We shall see.  It seems highly unlikely that they move on Wednesday, but we should at least get an inkling of how things may evolve going forward.

So, let’s turn to the markets.  It is no surprise that risk is on everywhere this morning after the Trump announcement so briefly, here is a screenshot from 6:40 this morning showing equity futures markets higher across the board.

Source: tradingeconomics.com

While these are just the major markets, the reality is that markets are higher everywhere except Oslo, as the decline in oil prices hits the Norwegian stock market.  But otherwise, it is universal.

Bond yields are lower across the board as well, with Treasuries (-4bps) leading the way and all of Europe seeing sovereign yields decline by between -4bps and -6bps as the inflation story follows oil lower.  JGBs, too, slipped -4bps overnight and are down -17bps in the past week!

But oil remains the story because its movement is what is driving the narrative.  And, interestingly, there is still strong support from one side of the argument that we are close to hitting tank bottoms and prices are going to shoot higher.  We have heard from both Chevron and Exxon that it is a dangerous situation and even the reopening of the Strait may not happen in time to stop it.  But consider if you are Exxon or Chevron, high oil prices are what you need as you sell your inventory rich and drilling is much more profitable.  And one thing they have is a lot of inventory in their refinery systems.  It hardly seems likely they would be out touting the deal as great and talking prices down.  We have heard throughout the conflict that in a few weeks, prices would spike higher as shortages developed, but that has never happened.  I go back to my view that ignoring market prices in favor of the narrative is a mistake.  At this point, with WTI at $80/bbl, I will argue we will see $50 long before we ever see $100 again.

As to metals markets, based on recent price action, it should be no surprise that gold (+2.75%), silver (+4.3%) and copper. (+0.7%) are all rallying on the lower inflation => lower interest rates => increased commodity demand.

Finally, the dollar is under pressure generally as the DXY (-0.25%) is a pretty good proxy for most things.  In truth, we are seeing some larger movements (INR +0.7%, SEK +0.8%, ZAR +0.6%, CHF +0.6%) all responding to the lower oil price, and in the case of the rand, the higher gold price.  However, there are two outliers here.  NOK (0.0%) is, not surprisingly, unable to show any traction, as like the Norwegian stock market, declining oil prices are a drag here, and JPY (+0.1% and still above 160.00).  The latter must really be concerning to Ueda-san as in a broad dollar decline, if the yen can’t gain traction, that is a real problem.

On the data front, there is a bunch of stuff, but other than Retail Sales on Wednesday, all of it is second tier.

TodayEmpire State Manufacturing14.0
 IP0.3%
 Capacity Utilization76.2%
TuesdayRBA rate decision4.35% (unchanged)
 Housing Starts1.44M
 Building Permits1.41M
WednesdayRetail Sales0.5%
 -ex autos0.5%
 FOMC rate decision3.75% (unchanged)
ThursdayInitial Claims232K
 Continuing Claims1790K
 Philly Fed10.0
 Leading Indicators0.1%

Source: tradingeconomics.com

In addition to all that, the G7 meets this week, starting this evening in Evian, France with French President Macron leading the group.  

As always there is a great deal of naysaying out there as the joint announcement of a deal between the US and Iran has upset the applecart for many narrative writers, and they are committed to their positions.  Personally, I am very happy to see the deal, although it was early as I had anticipated a July 4th outcome, but in this case, a much better result.  I guess it will take some time before it is clear if things are truly operating more normally again, but market pricing is demonstrating a willingness to believe.

With this in mind, the dollar should remain under some pressure for now, as prospects for a Fed rate hike are going to fade, although they haven’t yet according to the futures market, but if anything, that will simply mean that the US will suck in more global capital as the US economy continues to outperform elsewhere.  Ultimately, that will benefit the greenback.

Good luck

Adf

Frankly, Outré

Posted on by 
The rate of inflation expanded
Though core came out more evenhanded
The war in Iran
Ain’t going to plan
But oil’s not over demanded

However, the story today
Is SpaceX shares soon on their way
To stock market listing
Though some are insisting
Its value is, frankly, outré

It’s a funny thing lately, there has been quite a bit of market activity, but the narrative storylines are changing so quickly that they don’t seem to have a real impact.  So, every day there is some new thesis as to why prices are behaving in whatever manner they are.  It is almost as if the market is trying on different stories to see which one fits best.

As I am wont to do, I always like to step back and take a longer-term view on things as regardless of the daily wiggles, my experience is that those very big picture issues are what drive markets over time.  So, let’s review what I see as the key long-term drivers;

  • FX – ultimately, the combination of monetary and fiscal policies is critical in this space with a good rule of thumb being tight monetary and loose fiscal policy strengthen a currency while the opposite settings tend to weaken them.  When both policies are on the same setting, it is far less clear, although I would err on the side of monetary policy being the driver.  Key to this is that monetary policy tends to drive short-term flows.
  • Equities – earnings are still the ultimate issue here as, remember, shares represent ownership in a company (although the recent gamification of markets has certainly obscured that view).  Too, equities tend to be forward-looking, anticipating how future earnings are going to evolve.  The biggest change in this space has been the steady growth of passive investing, though, which represents more than 50% of the market now.  Passive investing simply means that as money flows into funds, like 401K’s, the funds buy stocks with the S&P 500 the most popular destination regardless of earnings and prospects.  So, flows are the other critical issue, just like in FX.
  • Bonds – despite much recent angst, Treasuries remain a haven asset and benefit from that status.  However, especially as you move out the maturity ladder, inflation expectations are the primary driver in an unencumbered market.  While much hay has been made regarding the extraordinary size of the US outstanding debt, now approaching $40 trillion, I do not believe we have reached a point where anyone believes they will not get their money back, albeit money that has been devalued by inflation.
  • Commodities – this is the space where supply and demand remain paramount, and really, it’s current supply and demand.  As such, the fact that oil is back below $90/bbl this morning tells us that a combination of increased non-OPEC supply plus some measure of demand destruction has found a new equilibrium level.  This remains far below the levels anticipated by many after the closure of the Strait of Hormuz, and there are still many analysts calling for a sharp move higher when all the mitigating factors that have prevented a much bigger move run out. This morning, Javier Blas at Bloomberg had an excellent piece describing his view of why oil prices aren’t higher despite the war.

Every narrative is an attempt to either describe or hide the longer-term issue, with much more hiding than describing in my experience.  But I stand by these concepts.

Which takes us to today’s narratives.  CPI yesterday was largely as expected, actually the core number at 0.2% M/M came in a bit light, but that stopped mattering about 2 minutes after the release.  Inflation has become a favorite subject about which to bitch, but very few do anything about it.  (if you want to do something, go to www.usdicoin.com and you can buy some USDi which is a fully backed inflation tracking cryptocurrency).  

There was a short resumption of military activity in the Gulf after a US helicopter was shot down by Iran and the US retaliated.  Frankly, I didn’t even read the details as they just don’t matter to the big picture.  It is unclear whether negotiations are ongoing, but the stalemate continues.

And finally, the truly big story, the SpaceX IPO this evening.  It is the one thing that has the most tongues wagging in the markets and if you read X, it appears there are many more analysts who believe the price is absurdly high than that it represents value.  I have no opinion on the deal but anecdotally, I did speak with someone last evening who just put money into a Fidelity VC fund that has stakes in all the big names (SpaceX, Anthropic, OpenAI) and a 10-year lockup and is very excited.  

So that’s where I see things this morning.  Yesterday’s US equity declines were followed by more weakness (China, HK, India, Australia, New Zealand) than strength (Korea, Singapore) in Asia.  Tokyo was essentially unchanged.  However, in Europe this morning things are much brighter with solid gains across the board.  US futures, too, are higher this morning by about 0.7% across the board as I type at 7:15.

In the bond market, yields have edged back down with Treasuries (-3bps) leading the way and European sovereigns right there with them.  Whatever longer term concerns about inflation exist are not showing up aggressively at this point.

In the commodity markets, oil (-1.1%) continues to underperform all the calls for catastrophe and another anecdote, I saw diesel below $5.00/gallon yesterday for the first time in several months.  Products are available.  As to the metals, they are uniformly hated although this morning both gold (+0.4%) and silver (+0.6%) have edged a touch higher.  However, the trend here in gold (and silver) is clearly back down for now. 

Source: tradingeconomics.com

Nothing has changed my longer-term concerns over fiat debasement, but for now, gold is not the play.

Finally, the dollar is somnolent this morning, with the euro, pound and yen all basically unchanged but sticking near recent dollar highs.  No matter how I slice it, I cannot come up with a significant dollar down story despite many having that view.  The US economy, by most measures, continues to drive global growth and I suspect that will remain the case for a while yet.

On the data front, this morning brings the weekly Initial (exp 219K) and Continuing (1780K) Claims data as well as PPI (0.7% M/M, 6.4% Y/Y) and core (0.5% M/M, 5.4% Y/Y).  We also hear from the ECB shortly, with a near universal belief that they will be hiking 25bps in order to drill for more oil push back against the recent energy induced price rises.  The beginnings of a major error in my view.

And that’s really it.  It has been getting more difficult to find interesting things to discuss, that’s for sure, and as we head deeper into the summer, the doldrums have a history of keeping things dull.

Good luck

Adf

Stoke Some More Fear

Posted on by 
The word of the day is inflation
As data from many a nation
Appears, still, to show
It has room to grow
With fears this is no aberration

But are things as bad as we hear
From media outlets who cheer
More pain, as they make
Their case Trump will break
The nation, and stoke some more fear

It’s CPI day here in the US and similarly, we got readings from various nations around the world overnight.  To level set, expectations for this morning’s numbers are:

  • Headline – 0.5% M/M, 4.2% Y/Y
  • Core – 0.3% M/M, 2.9% Y/Y

On an annual basis, as you can see in the below chart from tradingeconomics.com, 4.2%, while much higher than some recent data and much higher than we would like, was seen as recently as April 2023 during the “transitory” phase from the Covid years.

And don’t get me wrong, I am as sensitive to inflation as all of you as I go to the supermarket or Costco and see prices and fill up my car’s gas tank as well.  In fact, speaking of gasoline, there is no question it is much higher than it was prior to the beginning of the Iran conflict.  Looking at the chart I drew from FRED data below shows that, nominally, it is back at levels from the immediate aftermath of Russia’s invasion of Ukraine in 2022.  But look at the other line on the chart, that is the price of a gallon of unleaded adjusted for CPI starting back in 1990.  It is remarkable that the latest reading, while still obviously higher than a few months ago, is just $1.635/gallon in real terms.

Somebody else pointed out that gasoline is one of the few things that seems rarely to be described in real terms, arguably because it hasn’t really risen all that much over time and those who describe things in real terms are frequently trying to make the point that inflation is far too high.  Arguably, though, this is further proof of famed economist Julian Simon’s thesis that commodity prices all head lower over time as the ability to produce them in abundance, and their relative abundance in the earth, drive those prices lower.

As to elsewhere in the world, last night China reported that CPI (blue bars) remained at 1.2% but PPI, which may be a better indication of price activity there, rose to 3.9%.  This implies that Chinese corporate profits are under increasing pressure.  It also represents a sea change in China as can be seen in the below chart where PPI (grey bars) was negative for the 3 years prior to April.  

Source: tradingeconomics.com

As with all inflation analysis, the real question is who absorbs the price pressures.  In the US, the recent experience from Covid, when the government helicoptered $5 trillion into the economy so people had money to spend, businesses raised prices and continue to believe they can do so.  Apparently in China, that is not the case.  To finish the discussion, below is a chart of 17 of the G20 nations and their most recent headline CPI readings (I left out Argentina, Turkey and Russia as I couldn’t fit them all on the screenshot).  Interestingly, only 11 of these 17 nations have seen CPI rise in the past month.  I wonder, is inflation the global phenomenon that some make it out to be.

Country Last. Previous Date

Ok enough on that.  Let’s move on to market activity.  For the past several days, the oil story did not seem quite as important as despite a few random missiles being fired, it appeared that the Iran conflict was quieting down.  This allowed the focus to turn to important things like AI and the SpaceX IPO coming tomorrow after the close.  For example, when I sat down this morning around 5:00, oil was around $87.50/bbl and had slipped slightly lower compared to yesterday’s close.  However, in the interim, President Trump tweeted out the following:

But despite these comments, while oil has jumped as per the below chart, it is just barely at $90/bbl, hardly a sign the market believes something dramatic is on its way.

Source: tradingeconomics.com

In the meantime, there continue to be multiple articles that we are heading to the cliff for oil inventories and prices will skyrocket soon.  You know my opinion on those as I take the market’s side things are not as dire as some believe.

But if things heat up in Iran and the Gulf, I expect that we will see a downdraft in equities and bonds while the dollar moves higher.  And that is what we are currently seeing.  Below is a screenshot of equity futures markets as of 7:45 this morning.

source: tradingeconomics.com

Not a lot of happy faces there.  As well, overnight saw weakness throughout most of Asia after yesterday’s modest US declines.

In the bond market, Treasury yields are backing up 3bps and European sovereign yields are also higher this morning, between 3bps and 5bps across the entire continent.  So despite my statements above that inflation may not be as big a deal as some explain, bond investors are at least a bit uncomfortable this morning.

As to the metals markets, that break below the 200-day moving average in gold is seeing real follow through as old long positions and new short momentum plays pile on with the barbarous relic (-2.5%) tumbling as well as silver (-1.9%) and copper (-1.2%).  The key here is that whatever the short-term price action is, I think the one unalloyed truth is that fiat currencies will continue to get printed like there is no tomorrow and precious metals will regain their form.  But it could take a while.  In that vein, there was a Bloomberg article this morning explaining that more government bonds have been sold at this point in the year, ~$504 billion, than the first half of 2020 with Covid.  If my short-term inflation thesis is wrong, this is the reason why.

Finally, the dollar has edged higher this morning but is generally little changed.  The noteworthy thing is that USDJPY is at 160.50, above the supposed line-in-the-sand for the MOF, but as you can see from the below chart, the movement has been extremely gradual, with very little volatility.  Remember, one of the things the MOF focuses on is that volatility, so if the dollar continues to creep higher, they are likely to hold off for a while before feeling the need to intervene.

Source: tradingeconomics.com

But otherwise, most currency movement has been modest overnight.

Aside from CPI, and the oil inventory data, we do hear from the Bank of Canada, which is likely to leave policy rates on hold.

It feels like the market is getting increasingly concerned over an uptick in activities in the Gulf, which will have a negative impact on financial assets but support the dollar.  We shall see.

Good luck

Adf

The Narrative Shatter(ed)

Posted on by 
For months data just did not matter
Twas oil that drove all the chatter
But Friday that changed
As NFP ranged
So high that the narrative shatter(ed)

Now suddenly, eyes have all turned
To data, with many concerned
Their previous views
Will naught but confuse
All efforts, more cash, to be earned

Since the Iran conflict began on the 1st of March, pretty much the only key variable in financial markets has been the price of oil.  As you can see in the chart below, the price gapped higher that Monday morning and has been the major topic of conversation ever since.

Source: tradingeconomics.com

There continues to be a large contingent of analysts who, once the Strait of Hormuz was closed, have been calling for a substantial rise in the price of the stuff, but here we are this morning, back below $90/bbl and lower by -2.3% on the day.  Stories about declining reserves, floating reserves, demand destruction and new production are all available on any given day, and all certainly have facts to support them.  But the big picture, at least so far, has been that the market has found a clearing price between the release of strategic reserves and some amount of demand destruction, which has kept prices in check.

The greatest irony to me is that all the discussion regarding the long-term damage high oil prices are going to inflict on the economy seems to ignore the cardinal rule of commodities; the cure for high prices is high prices.  Last week I highlighted comments from an Exxon SVP about the coming crisis.  If that is Exxon’s corporate belief, they will be drilling like there is no tomorrow as their costs are far below current price levels, let alone the mooted rise to $150/bbl.  However, if we look at the one source of data that discusses drilling, the Baker Hughes oil rig count, you can see in the below chart that while it is a few rigs off its recent lows, there is still limited oil industry belief that the price is going to remain this high for any extended length of time.

Source: tradingeconomics.com

I think what last Friday’s very surprising employment report has done is to change some of the thinking of investors, turning their attention from exclusively oil to the rest of the economy and, now that we are 3+ months into this adventure, to how the rest of the economy is behaving.

This brings us to the two key pieces of information that are upcoming in the US, tomorrow’s CPI report and then next Wednesday’s FOMC meeting.  But it also has market participants going back to their more regular processes with discussion of market technicals, earnings, and global policy decisions.  So, let’s look in those areas this morning.

On the policy front, a few things happened overnight.  First, Bank Indonesia raised their base rate 25bps, to 5.50%, in an emergency meeting as the rupiah continues to decline to record lows, although in the wake of the rate hike, it rebounded some 0.8% as per the below chart.  Another data point is the fact that their FX reserves have fallen by >$1 billion in the past month indicating that they are actively intervening to prevent a further decline.  Too, this comes after a 50bp hike just two weeks ago.

Source: tradingeconomics.com

Elsewhere on the central bank front, Nikkei news reported that the BOJ will be raising its base rate by 25bps, to 1.00%, the highest level since 1995, when it meets next Monday night (recall, Nikkei has a perfect track record when calling these moves).  This has been widely expected in the market, and so there was no reaction in the FX market, although with USDJPY hovering just above 160.15 this morning, I imagine there is a bit of nervousness at the Ministry of Finance there.  Interestingly, the word from Nikkei is also that they may end the tapering of the balance sheet next year, which certainly detracts from the hawkishness of the rate move.

Moving on to data, the noteworthy datapoint overnight was the Chinese Trade Balance ($105.4B), which while somewhat larger than expected is right in line with recent activity as per the below chart.  It seems that demand for semiconductors has been significant and while trade with the US continues to remain moderate, the rest of the world is getting inundated with Chinese stuff.

Source: tradingeconomics.com

The one other major topic of conversation is the SpaceX IPO set for Thursday and the fact that OpenAI filed to go public as well.  I expect that those discussions are going to be a large part of the equity market narrative for a while yet, but that is well outside the purview of this note.

So, let’s look at market behavior and then see what is on tap for the week data wise.  Friday’s equity declines in the US were like a bad dream, they felt terrible but now it seems everybody has awakened and the world did not end.  Yesterday saw a steady climb from opening lows all day with the NASDAQ closing higher by +0.9%.  The upshot is that Asian markets broadly followed that movement with Japan (+2.2%), China (+1.9%), Korea (+8.2%!), Taiwan (+2.8%) and Indonesia (+7.6%!) all shaking off fears and rebounding sharply.  While HK (-0.4%) and Australia (-0.2%) both lagged, the other regional markets were broadly positive.  I continue to be amazed at the idea that Asia is in the worst energy shape and yet its equity markets are screaming higher.

In Europe, there is also a positive vibe with Spain (+1.2%), France (+0.9%) and Germany (+0.7%) all having solid sessions.  In fact, only the UK (-0.2%) is lagging this morning and not based on any data, but it seems more like some idiosyncratic stories regarding pharma companies there.  As to US futures, at this hour (7:20), they are firmer by 0.5% or so across the board.

In the bond market, yields, which have been moving higher for the past week, have backed off a bit with Treasury yields down -2bps while European sovereign yields have also slipped, mostly by -1bp or -2bps.  Last night, JGB yields (-4bps) fell after the story about the rate hike.  Perhaps investors believe Ueda-san is going to be more hawkish.  But it seems they missed the story about ending QT.

In the commodity space, with oil lower, as discussed above, it is no surprise that gold (+0.5%), silver (+0.6%) and copper (+1.7%) are all higher.  In the gold market, much has been made of the fact that technically, gold closed below its 200-day moving average Friday and has stayed there so far.  If this continues, it will be seen as a negative medium-term signal.  (my chart is showing the 40-week as I cannot get a long-term chart of the 200-day, but it is essentially the same thing.)

Source: tradingeconomics.com

Finally, in the currency markets, the dollar has backed off its recent highs this morning with the DXY (-0.3%) back below 100 and its decline a pretty good proxy for most of the G10 currency’s movements.  This is in no way a rout, but a correction after a strong move higher over the past month as you can see in the below chart.

Source: tradingeconomics.com

On the data front, we see the following this week.

TodayTrade Balance-$56.1B
 Existing Home Sales4.07M
WednesdayCPI0.5% (4.2.% Y/Y)
 Ex-food & energy0.3% (2.9% Y/Y)
ThursdayInitial Claims219K
 Continuing Claims1780K
 PPI0.7% (6.4% Y/Y)
 Ex-food & energy0.4$ (5.3% Y/Y)
FridayMichigan Sentiment46.0

Source: tradingeconomics.com

So, all eyes will be on CPI tomorrow as Fed speakers are now in their quiet period ahead of next week’s meeting.  Certainly, there is very little I have seen that is going to moderate inflation in the near term, but perhaps, if we do see an end to the Iran conflict, that will remove a key price support, although I imagine it will take time to feed through.  But inflation is highly dependent on how much money is around, and that is what makes the FOMC next week so critical.  Until then, it feels like a limited price action day today as we all await CPI tomorrow.

Good luck

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Changing the Fate

Posted on by 
With things in the Gulf getting hotter
And risk assets heading to slaughter
The question on lips
Can stocks e’er eclipse
Their highs, or ‘stead sink ‘neath the water
 
But really, the question I’d ask
Is Chairman Warsh up to the task
Of changing the fate
Of the Fed funds rate
And if so, what will he unmask?

It is very difficult to focus on the Gulf situation as not only is it fluid, but there is also no direction of travel whatsoever.  So, this morning I want to have a different conversation.  Let me start by explaining this isn’t my idea, per se, although the analysis is solely mine.  Listening to the Macro Voices podcast Sunday morning while walking the dog, (he’s the one on the left)

Michael Every was on and expressed a very interesting thought, one that I had not considered, nor heard anywhere else.  What if the Fed, as Chairman Warsh seeks to adjust how it works, decides that they are going to put their fingers on the scale with respect to the interest rates paid by different industries, not merely by differently rated credits.  The idea is that in conjunction with the Treasury, Warsh and Bessent would decide which industries needed to have the most cost-effective funding for the nation to be able to maintain and develop the industries necessary for national defense reasons.

Now, I know this is anathema to almost all of us having been raised on the idea(l) of free markets and that markets are better at allocating, well everything, but in this case credit, than any cabal of central bankers.  And in a world where markets were truly free and where everyone competed on a level playing field, I am 100% in agreement with that view.  Alas, I’m not sure if you noticed, but that is not the world in which we live.

If Covid taught us nothing else, it was that 40 years of globalization and creating the most efficient processes for manufacturing resulted in significant fragility in those very processes.  It turns out that while economists in the US, Europe, Japan, the World Bank and IMF all explained that this was a great outcome (the US prints paper notes and gets lots of stuff for it), that only works when there is peace on earth.  During this period, China chose to play by a different set of rules, explaining they were just a poor country so didn’t need to play by the G10’s rules, and massively subsidized numerous industries while essentially ignoring all environmental issues.  That tilted the playing field pretty aggressively, and while President Trump has been adamant about that very issue for a decade, he was largely ridiculed, right up until Europe recently figured out that China was eating their lunch too, and now they are looking to impose tariffs on China’s excessive exports.  There is an excellent Substack that comes out Sunday mornings called The Brawl Street Journal,written by an analyst in Germany.  This week’s, linked here, explains that very issue extremely well.

So, I’ve set the table here, and the key to understand is the table is tilted horribly, with China getting the benefit of the doubt for almost everything.

Now, let’s consider what Mr Every’s idea would mean.  Below is a chart showing current 10-year yields for Treasuries and a series of corporate bonds delineated by their credit ratings.

Data: streetstats.finance

Makes sense, less creditworthy names pay more.  That is how things have always been within a market system as the worse the credit rating, the higher the perceived risk of the investor and therefore the higher yield they demand.

But what if that were to change?  What if the Fed and Treasury decided that companies that manufactured products, be they semiconductors, automobiles, tractors, airplanes or flat panel screens, and mining companies that mined in the US (and Canada) and energy extraction companies that drilled in the US (and Canada) needed a lower cost of capital to be more competitive globally as those companies were the ones necessary for the US to maintain its global hegemon status.  But media companies, and retailers, non-bank financial institutions and home health services companies, for example, were not deemed as critical.  Perhaps the new “credit” curve might look like this instead (all hypothetical)

The point is, China has been subsidizing numerous manufacturing industries for decades with the goal of excess production designed to drive other nations’ competitors out of business and gain a strategic advantage in all those industries.  It is why President Trump’s tariffs were a problem for them, and the rest of the world, as the US had been the dumping ground for much excess Chinese production in the past, and now that stuff is going elsewhere.  

The world we once knew is no longer the world in which we live.  Mr Every’s term, economic statecraft, is much more applicable today than any time in the past 40 years, probably longer, since the end of WWII.  Statecraft implies nations will use all the power they have, economic, military and diplomatic, to achieve their desired goals.  For more than 70 years, the US did not play by those rules under the assumption that if they created a level playing field, and even tilted it in favor of weaker allies, peace would reign.  China doesn’t play by those rules, and that is how we have arrived where we are.  

This is all hypothetical, but remember, Chairman Warsh has talked about restructuring the Fed.  All the economists think he is talking about shrinking the balance sheet.  But what if he is talking about completely changing credit markets with Fed support?  I would argue that is not on many bingo cards.

So, briefly, let’s consider how markets would respond to this action by the ‘new’ Fed.  Here are my conclusions, I would love to hear yours.

  • Stocks – broadly lower, although clearly favored sectors would continue to perform well.  But overall leverage would shrink and that has been a huge part of this rally.
  • Bonds – a steeper Treasury yield curve seems certain as subsidies for those favored industries will weigh on the US budget.  Meanwhile, non-favored industries would find themselves with real difficulties in terms of financing.
  • Commodities – offsetting forces here as industrial metals would see increased demand, and getting supply on line takes years if not a decade, but energy may result in a glut sooner as drilling takes much less time to get going.  Precious metals would soar, I believe, on the basis of investors and central banks, seeking an asset with no counterpart.
  • FX – this is the toughest call as different nations will be impacted in very different manners.  Commodity producing nations (e.g., Chile, Norway, US) should see relative strength.  Consuming nations would likely suffer somewhat, although Japan and Korea, for instance, could essentially fall within the US umbrella as their key industries are the US focus.

Again, this is all hypothetical but is probably worth some thought.  In the meantime, a brief tour of markets overnight after Friday’s sharp declines in the US shows nobody is very happy this morning.  The tradingeconomics.com screenshot below shows futures as of 6:10am.

What sticks out to me is Italian equities are bucking the trend, although there has been no data and I cannot find a specific catalyst there.  Also, it is interesting that US futures are broadly higher this morning despite growing concerns that the situation in the Gulf is going to heat up again.  But Asia had a rough session and most of Europe is feeling a little pain as well.

In the bond market, after climbing on Friday, yields continue higher this morning across the board.  The below Bloomberg screenshot explains things well.  Recognize that Canadian and Mexican markets haven’t opened yet and Australian markets were closed last night for the King’s Birthday.  But net, there is growing concern over inflation on a worldwide basis it appears.  

Turning to the commodity markets, oil (+3.8%) is higher again, after falling on Friday as there were missile attacks by Iran on Israel in response for Israel’s ongoing attacks on Hezbollah in Lebanon. This situation remains fraught and frankly nobody has any idea when it will settle down into something a bit less volatile.  If we look at a chart of the past six months of oil price movement, I have drawn a line at $95/bbl, which to my eye offers a pretty good estimate of the average since things began.  There are still many doomsayers who believe $200/bbl oil is coming soon, but that has been their forecast since March.  Something to remember about commodity markets is that they do not forecast the future, they are the prices at which physical stuff clears, so it appears that so far, there is ample inventory available.

Source: tradingeconomics.com

Not surprisingly, given the recent relationship between gold and oil, the barbarous relic is lower this morning by -0.7% while silver, though unchanged on the day, suffered dramatically on Friday, falling $6/oz or about 8%.

Finally, the dollar is little changed this morning, but that is after a sharp rally on Friday in the wake of the much better than expected NFP data (+172K with revisions higher in the previous two months of +93K) which helped push yields higher as a rate hike this year has now been priced by the futures market as per the below CME table.

But more than just the futures market is thinking that way.  The below chart showing the 2-year Treasury vs. Fed Funds shows that not only have 2-year yields moved above Fed funds, but they are accelerating higher.  This is seen as another harbinger of a higher Fed funds rate.

Source: tradingeconomics.com

So, the DXY is back over 100.00, USDJPY breeched 160.00, and is right on that number as I type at 6:50am, and generally, the dollar is pushing the top of its recent ranges.  The one exception here is KRW (+1.6%) where the central bank and Finance Ministry both were actively jawboning the currency higher after it traded to yet another new low (dollar high).

As there is no data of note this morning, I will go through that tomorrow given how long things got today.  The world is changing rapidly and the most important thing, I think, is to recognize that old relationships may no longer be valid.  Nimbleness is critical, whether investing or hedging.

Good luck

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In Secret, Would Toil

Posted on by 
Since March, traders focused on oil
Where every explosion could roil
The bulls and the bears
In bonds and in shares
While data, in secret, would toil

Today, though, the payroll report
Is taking bows on center court
For those who are long
The buck, they need strong
Results, while a weak one helps short(s)

For a change of pace today, the market truly seems to be looking at the data release rather than the latest zig or zag in Iran.  It has been at least four months, since before the first bombs dropped in March, that this data point has had any real import for the narrative, so it is a welcome return to what we used to consider normal.  With that in mind, let’s look at what the current expectations are:

Nonfarm Payrolls85K
Private Payrolls85K
Manufacturing Payrolls2K
Unemployment Rate4.3%
Average Hourly Earnings0.3% (3.4% Y/Y)
Average Weekly Hours34.3
Participation Rate61.7%

Source: tradingeconomics.com

While 85K is much lower than the pre-Trump 2.0 level deemed necessary to maintain a strong labor market, it is abundantly clear that between the closure of the borders and the deportations, that is no longer the situation.  Estimates I have seen to achieve labor stability have been between 0 and 50K, and that includes comments from former Fed Chair Powell.  While an outturn at the forecast level would be lower than last month, it would still indicate the labor market is in decent condition.  Of course, one of the hardest things is to see through the revision noise as the BLS birth/death model describing new companies is clearly not representative of the current economy.  Below is a look at the past five years of monthly reports which is showing a clear trend lower, but as per the above, that may not be a problem.

Source: tradingeconomics.com

However, the other data we have seen lately, notably the strong ADP number, the solid employment subindices from the ISM data and the fact that claims data, although a touch higher yesterday, remains very contained, tells me that we are going to see a better number than forecast, something around 115K like last month.

Perhaps the real question is why this matters now.  Well, as the war fades into the background, and remarkably that is what is happening, investors are back to looking for clues as to how the economy is performing and how the Fed is likely to behave going forward.  Several times this week I have highlighted the importance of capital flows, and a key part of that story is central bank liquidity being available to flow.  Thus, if the Fed sees this data and leans more toward tightening, that is likely to have a negative impact on those markets that require easy money like stocks, high-yield debt and private markets.  Interestingly, if bond traders sense that the Fed is going to pay closer attention to inflation, that should help the long end of the bond market, and we could see a bull flattener result.  Nothing has changed in the Fed funds futures market, but that is something that could really move on an outlier number here.  We will learn soon enough.

Away from that, though, the most interesting thing I have seen is the below tweet although the commentary was strongly of the opinion that this is fake news.  If it is real, that is a major breakthrough in leading to the end of the war, however, based on the fact that oil prices are essentially unchanged (-0.15%), the market does not appear to believe the story.

Ok, let’s see what else is happening in other markets.  Not surprisingly, gold (-0.25%) is also not doing much but both silver (-1.7%) and copper (-1.6%) are softer despite the fact oil’s little changed.  Metals appear to have lost some of their luster for now, but I do believe that their long-term prospects remain strong.

In the stock markets, yesterday saw the DJIA take the lead for a change, rallying to a new all-time high although the NASDAQ went nowhere as questions about the AI story are beginning to be raised.  Too, semiconductor stocks, which have been extraordinarily strong, are beginning to be questioned given the highly cyclical nature of that business.  Yesterday Harris Kupperman wrote a very interesting piece on semiconductors which I think is worth reading.

In the meantime, Asian markets followed the tech lead from NASDAQ and were virtually all lower, some extremely so.  The worst case was Korea (-5.5%) followed by Indonesia (-4.2%) but the major indices all fell as well (Tokyo -1.3%, HK -1.15%, China -1.8%).  Tech took a beating.  Of course, for Europe, since they basically have no tech, markets are having a much better day with Spain (+1.1%) leading the way followed by France (+0.5%), the UK (+0.4%) and Germany (+0.2%).  Perhaps the fact that Eurozone GDP for Q1 was revised down to -0.2% Q/Q and +0.3% Y/Y has some thinking the ECB may not (stupidly) raise rates due to the oil shock.  But if that’s the case, you cannot tell by the interest rate markets which show the current probabilities as per the ECB itself.

At this hour (7:40) US futures are mixed with the NASDAQ (-0.9%) still suffering while the DJIA (+0.2%) continues to smile.

Apparently, global bond markets are collectively holding their breath ahead of the data point as yields are essentially unchanged in the US, Europe and were unchanged last night in Asia.

Finally, the dollar is slightly softer this morning, although remains above 99 on the DXY and is merely chopping back and forth within the extremely tight range of the past 3 weeks I show, once again, below.

Source: tradingeconomics.com

Most movement today across both the G10 and EMG blocs is +/-0.25% or less, hardly the sign of a trend.  The one exception is INR (+0.8%) after the RBI left rates on hold, as expected, but instituted several measures to try to attract foreign capital such as easing investment rules for foreigners.  We shall see if that has a long-term benefit, but at least the rupee has put a little space between the current level and the bottom (dollar top) seen two weeks ago.

Source: tradingeconomics.com

And that’s really all for today.  So, absent news about real movement toward the end of the Iran conflict, it’s payrolls then a summer Friday where many will be seeking to leave early.  If I am correct and we see a stronger number, I see the dollar benefitting which should hurt the metals, although oil is independent of this news.  Since this would imply more chance of a Fed rate hike, I expect stocks would not be pleased, nor will bonds.  We shall see.

Good luck and good weekend

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One Sixty

Posted on by 
The asymptote nears
Will they act at One Sixty?
Can they afford to?

Yesterday saw the yen edge ever closer to the 160 level, the point at which the MOF/BOJ acted in April.  Frankly, looking at the chart, it reminds me of an asymptotic limit from calculus, but the one thing we know is there is no natural limit, only whatever artificial one is imposed (or tried to be imposed) by the Japanese government.

Source: tradingeconomics.com

The market continues to price a high probability, ~86% according to the OIS market, of a 25bp hike by the BOJ next week, and I’m confident they will do that.  But to me, the question is, will it matter to the FX markets?  Here’s the thing about FX, typically there are two separate, but related, drivers of the relative value of one currency vs. another.  The most common discussion is about short-term interest rate differentials, typically proxied by central bank base rates.  Below is a chart of the past ten years of data for Fed funds (grey line), BOJ base rate (blue line) and USDJPY (brown line).

Source: tradingeconomics.com

It is abundantly clear that there is a strong relationship here, as US rates shot higher in the post-Covid inflation bout and USDJPY shot higher as well.  Now, since the Fed started cutting rates back in September 2024, while Japanese rates have edged higher over the same time frame, it would be reasonable to assume that USDJPY should retreat somewhat.  However, as you can see in the first chart, that is just not happening.  In fact, the pressures are the other way, with far more weakness than strength.

Why, one might ask, is this the case?  This takes us to the other major factor in FX rates, relative capital flows.  Nations that see substantial inflows in capital will typically see their currencies appreciate.  Now, ask yourself, which nation sees the biggest inflows of capital in the world?  Yes, the US, as the capital account surplus is the mirror image of the massive current account deficit that we run.  In fact, if you look at the below chart, it shows the relative current accounts of Japan (grey bars) and the US (blue bars) in percentage of GDP which most recently showed -3.6% for the US and +4.7% for Japan.

Source: tradingeconomics.com

Now, let’s do the math.  US GDP is ~$28.8 trillion while Japanese GDP is ~$4.4 trillion.  3.6% of $28.8 trillion = ~$1.037 trillion of capital inflows.  4.7% of $4.4 trillion = $202 billion of capital outflows.  Of course, we know that everybody in the world is piling into US technology stocks, and that is where the capital is mostly flowing, but in order to do so, they are buying USD.  This is true of Japanese investors as well as others around the world.  

There is a narrative that is developing that claims as the Japanese raise interest rates, the massive, short yen positions that exist to fund many speculative trades will unwind, and with that, the yen will strengthen dramatically as well as we will see many other markets sell off sharply as those positions unwind.  But the NASDAQ is up 21% YTD and 40% in the past year.  If you are an investor and you are funding a speculative position at 0.75% annually that rises to 1.00% while you are returning 40% on the other side, do you really care?

To my eye, for the yen to change course, intervention is irrelevant, and so is a 25bp rate hike.  We need to see a wholesale change in the combination of Japanese fiscal and monetary policies as well as changes in those policies in the US.  Historically, a tight monetary and loose fiscal policy combination will strengthen a currency (something that the US currently has), but can Japan afford to tighten monetary policy that much?  My money is on no, and while 25bps seems pretty certain next week, I would not be looking for USDJPY fall very far, if at all.  And remember, the market is pricing a 50% chance of a Fed hike by the end of the year.  Don’t be taken in by this story in my view.

Away from this issue, it is difficult to find other critical news.  Yes, there was another skirmish in Iran straining the concept of a ceasefire, but all-out war has not resumed.  The elections in California and LA will take several weeks to determine who will be on the ballot in November, which, when you think about it, sums up the incompetence of California governance writ large.  

So, oil is higher along with the dollar and yields, but so are stocks, while metals slip.  Let’s look at the overnight activity.  Another set of equity records in the US was followed in Asia by broad based strength as Tokyo (+2.5%), China (+0.5%), Korea (+0.2%) and Taiwan (+2.0%) all continued to climb. Both HK (-1.6%) and India (-0.4%) were not as robust with the former seeing profit taking after a few strong sessions while the latter felt pressure from those rising oil prices.  One outlier here was Indonesia (-4.5%) which suffered after weaker than expected trade data, higher than expected inflation data, and a weakening rupiah which set another record low (dollar high), touching 18,000.

European bourses, meanwhile, are mostly under pressure after President Trump has devised a new way to impose tariffs on nations that allow “forced labor” which is defined as “all work or service which is exacted from any person under the menace of any penalty for its nonperformance and for which the worker does not offer himself voluntarily.”  One must give the president props for his continuous efforts to impose tariffs, if nothing else.  At any rate, Germany (-0.9%) is leading the way lower, followed by Italy (-0.3%), France (-0.2%) and the UK (-0.2%) although Spain (+0.5%) is bucking that trend on the strength of the earnings for Inditex (Zara clothing parent) which is one of the largest companies in the nation.  US futures, at this hour (6:40) are mixed.

In the bond market, yields are rising again on the back of the oil price rise with Treasury yields (+4bps) gaining alongside the entire European sovereign market, all of which have risen a similar amount.  Last night, JGB yields also rose 6bps, as they respond to the oil market as well as pending rate hikes by the BOJ.

In the commodity market, if you think back to late May, you may recall an announcement that a deal with Iran was close which prompted a gap lower in oil prices as you can see in the chart below.  Well, that gap has now been filled.

Source: tradingeconomics.com

Just as nature abhors a vacuum, markets abhor a gap and seek to fill it whenever possible.  My take here, though, is now that the gap is filled, there is less reason to see oil rally much further and a consolidation before a slow decline is in the cards.  As to metals markets, gold (-0.8%), silver (-1.2%) and copper (-1.1%) are all softer on the day, with their negative correlation to oil intact.

Finally, the dollar is firmer this morning, keeping in line with its recent relationship with other markets.  However, the movement remains relatively muted with most G10 currencies softer by -0.2% or so as only SEK (-0.6%) and NOK (+0.1%) really buck that trend.  NOK is clearly benefitting from the oil price rise while SEK seems to be suffering from a slightly higher beta to the broad dollar move.  In the EMG bloc, KRW (-0.9%) is the laggard as it continues under pressure and trading to its lowest levels (highest dollar) since 2009.

Source: tradingeconomics.com

But otherwise, most of these currencies are slipping a similar amount to the G10 bloc, on the order of -0.2% or so.

On the data front, this morning brings ISM Services (exp 53.8) as well as Factory Orders (4.6%, 0.8% ex-Transport) and then the EIA crude oil inventories with another sizable draw anticipated.  At 2:00, the Fed’s Beige Book is released which should make for some interesting reading.  Yesterday’s JOLTs data was surprising in that it showed a significant jump in job openings, 700K more than expected which does not portray a weakening labor market.

Overall, equity markets seem to be disconnected from the impact of oil prices, something that very few analysts would have forecast in February.  But the dollar remains closely linked to those prices for now.  As we all sit here, waiting for the next headline, I cannot help but look at the US data and consider that the economy continues to tick over pretty well.  Ultimately, I believe that bodes well for the dollar over time, or at least until some other major economy shows it can perform well.

Good luck

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