Tag Archives: #inflation

A Fifth Wheel

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Confusion is clearly what reigns
As even the punditry strains
To understand whether
Investors will tether
Their future to stocks or take gains

 

As there was no activity in the US financial markets yesterday, it seems there was time for analysts to consider the current situation and make pronouncements as to investor behavior.  Ironically, we saw completely opposite conclusions from two major players.  On the one hand, BofA posted the following chart showing that investors’ cash holdings are at 15-year lows, implying they remain fully invested and quite bullish.

Meanwhile, the WSJ this morning has a lead article on how bearish investors are, claiming they are the most bearish since November 2023 according to the American Association of Individual Investors.  Apparently, 47.3% of investors surveyed believe stock prices will fall over the next 6 months.

So, which is it?  Are investors bullish or bearish?  To me this is a perfect description of the current situation.  Everyone is overloaded with information, much of which is contradictory, and so having a coherent view has become extremely difficult.  This is part and parcel of my view that the only thing we can clearly expect going forward is an increase in volatility.  In fact, someone said that Donald Trump is the avatar of volatility, and I think that is such an apt description.  Wherever he goes, mayhem follows.  Now, I also believe that people knew what they were voting for as change was in demand.  But for those of us who pay close attention to financial markets, it will take quite the effort to keep up with all the twists and turns.

Fed speakers are starting to feel
Like they have become a fifth wheel
So, let’s get prepared
For Fed speaking squared
As they work, their views, to reveal

Away from the conundrum above, the other noteworthy thing is that FOMC members are starting to feel left out of the conversation.  Prior to President Trump’s inauguration, market practitioners hung on their every word, and they apparently loved the power that came with that setting.  However, now virtually every story is about the President and his policies with monetary policy falling to a distant issue on almost all scorecards.  Clearly, for a group that had grown accustomed to moving markets with their words, this situation has been deemed unacceptable.  The solution, naturally, is to speak even more frequently, and I fear believe this is what we are going to see (or hear) going forward.  

Yesterday was a perfect example, where not only, on a holiday, did we have multiple speakers, but they actually proffered different messages.  From the hawkish side of the spectrum, Governor Michelle Bowman, the lone dissenter to the initial 50bp rate cut back in September, explained caution was the watchword when it comes to acting alongside President Trump’s mooted tariff and other policies, “It will be very important to have a better sense of these policies, how they will be implemented, and establish greater confidence about how the economy will respond in the coming weeks and months.”  That does not sound like someone ready to cut rates anytime soon.

Interestingly, from the dovish side of the spectrum, Governor Christopher Waller, an erstwhile hawk, explained in a speech in Australia (on the day the RBA cut rates by 25bps for their first cut of the cycle and ending an 18 month period of stable rates) that, “If this wintertime lull in progress [on inflation] is temporary, as it was last year, then further policy easing will be appropriate.”  I find it quite interesting that Governor Waller suddenly sounds so dovish as many had ascribed to him the intellectual heft amongst the governors.  This is especially so given that is not the message that Chairman Powell articulated either after the last meeting or at his Humphrey-Hawkins testimony recently.  

So, which is it?  Is the Fed staying hawkish or are they set for a turn?  That will be the crux of many decision-making processes going forward, not just in markets but also in businesses.  We will keep tabs going forward.

Ok, on to the market’s overnight performances.  Lacking a US equity market to follow, everybody was on their own last night which showed with the mixed results.  Japan (+0.25%) showed modest gains while the Hang Seng (+1.6%) rocketed higher on the belief that President Xi is going to be helping the economy, notably the tech firms in China, many of which are listed in Hong Kong.  Alas, the CSI 300 (-0.9%) didn’t get that memo with investors apparently still concerned over the Trump tariff situation.  Elsewhere in the region, Korea and Taiwan rallied while Australia lagged despite the rate cut.  In Europe, unchanged is the story of the day with most bourses just +/-0.1% different than yesterday’s close.  Right now, in Europe, the politicians are trying to figure out how to respond to the recent indication that the US is far less interested in Europe than in the past, and not paying close attention to financial issues.  As to the US, futures at this hour (7:25) are pointing higher with the NASDAQ leading the way, +0.5%.

In the bond market, yields are climbing led by Treasuries (+4bps) with most of Europe seeing yields edge higher by 1bp or 2bps as well.  Remember, yesterday European sovereign yields rose smartly across the board.  Also, I must note JGB yields (+4bps) which have made further new highs for the move and continue to rise.  It appears last night’s catalyst was a former BOJ member, Hiroshi Nakaso, explained he felt more rate hikes were coming with the terminal rate likely to be well above 1.0%.  While I believe the Fed will be cautious going forward, I still think they are focused on rate cuts for now.  With that in mind and the ongoing change in Japanese policy, I am increasingly comfortable with my new stance on the yen.

In the commodity markets, last Friday’s sell-off in the metals markets is just a bad memory with gold (+0.5%) rallying again and up more than 1% since Friday’s close.  I continue to believe those moves were positional and not fundamental.  Too, we are seeing gains in silver (+0.2%) and copper (+0.6%) to complete the triad.  Meanwhile, oil (-0.25%) continues to lag, holding above its recent lows but having a great deal of difficulty finding any buying impulse.  Whether that is due to a potential peace in Ukraine and the end of sanctions on Russian oil, or concerns over demand growth going forward is not clear to me, but the trend, as seen in the chart below, is clearly downward and has been so for the past year.

Source: tradingeconomics.com

Finally, in the FX markets, the dollar is firmer this morning rising against all its G10 counterparts with NZD (-0.6%) the laggard.  But losses of -0.2% are the norm this morning.  In the EMG bloc, we are seeing similar price behavior in most markets although MXN (+0.2%) is bucking the trend, seemingly benefitting from what appears to be a hawkish stance by Banxico and the still highly elevated interest rate differential in the peso’s favor.

On the data front, Empire State Manufacturing (exp -1.0) is the only data point although we will hear from two more Fed speakers, Daly and Barr.  I cannot believe that they have really changed their tune and expect that caution will remain their guiding principle for now, although I expect to hear that repeated ad nauseum as they try to regain their place in the spotlight.

Aside from my yen view, I still find it hard to be excited about many other currencies for now.  There is still no indication the Fed is going to move anytime soon, and other central banks are clearly in easing mode.  That bodes well for the dollar going forward.

Good luck

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Shattered His Dreams

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The data was hot yesterday
And that put the pressure on Jay
It shattered his dreams
‘Bout all of his schemes
To help keep inflation at bay

 

By now, I am sure you are aware that the CPI data was higher than forecast, and certainly higher than would have made Chairman Powell comfortable.  The outcome, showing Headline rising to 3.0% and core rising to 3.3% with correspondingly higher monthly rises was sufficient to alter the narrative at least a little bit.  Chair Powell even mentioned it in his House testimony, noting, “We are close, but not there on inflation…. So, we want to keep policy restrictive for now.”  Essentially, the data makes clear that the Fed is not going to be cutting the Fed funds rate anytime soon.  The futures market got the message as it is now pricing just 29bps of cuts this year, with December the likely date.

It will be no surprise that the stock market’s initial response was to sell off substantially, but as per the chart below, it spent the rest of the day clawing back the losses and wound up little changed on the day.  This morning, it remains basically unchanged as well.

Source: tradingeconomics.com

Treasury bonds, though, had a less fruitful session, falling (yields rising) sharply on the print, but never really regaining their footing with yields jumping almost 15bps at one point although finishing the day about 10bps higher and have given back 2bps more this morning.

Source: tradingeconomics.com

Now, we all know that the Fed doesn’t target CPI, but rather PCE.  However, after this morning’s PPI data release, most economists (although not poets) will be able to reasonably accurately estimate that data point for later this month, as will the Fed.  And that number is not going to be moving closer to their 2.0% target.  What seems very clear at this point is that every Fed speaker for the time being is going to be harping on the caution with which they are going to move forward.

If we look at this from a political perspective, something which is unavoidable these days, it is important to remember that Treasury Secretary Bessent has made clear that he and the president are far more focused on the 10-year yield than on the Fed funds rate.  To that end and given the fact that all this data was from a time preceding President Trump’s inauguration, I don’t think they are too worried.  I would look for the President to continue his drive to reduce waste and fraud in the government and attack that deficit.  Certainly, the news to date is there is a great deal of both waste and fraud to reduce, and if the president is successful, I believe that will play out in significantly lower 10-year yields, if for no other reason than the deficit is reduced or closed.  This story is just beginning to be written.

Now, Putin and Trump had a call
As Trump tries to end Russia’s brawl
They’re slated to meet
So, they can complete
A treaty with Europe awol

Under any interpretation, I believe the news that Presidents Trump and Putin are going to meet in an effort to hammer out an end to the Russia/Ukraine war is good news.  Beyond the simple fact that less war is an unadulterated good, I think it is very clear that this particular war has had significant market impacts, hence our interest here.  Obviously, energy prices have been impacted, as both oil and NatGas prices are higher than they would otherwise be given the removal of some portion of Russia’s exports from the global markets and economy.  As such, the end of this conflict, with one likely consequence being Western Europe reopening themselves to Russian energy imports, is likely to see prices decline.  

This matters for more reasons than the fact it will be cheaper to fill up your tank at the gas (petrol) station, it is very likely to have a very positive impact on inflation writ large.  As you can see from the chart below, there is a very strong correlation between the price of oil and US inflation expectations.  Declining oil prices are very likely to help people perceive a less inflationary future and will reduce the rate of inflation by definition.  

Source: ISABELNET

Inflation is an insidious process, and once entrenched is very hard to reduce, just ask Chairman Powell.  I also know that there has been much scoffing at President Trump’s claims he will reduce inflation, especially with his imposition of tariffs all over the place. (It is important to understand that tariffs are not necessarily inflationary by themselves as well explained by my friend the Inflation guy in this article.). However, between his strong start on reducing government expenditures and the potential for an end to the Russia/Ukraine war leading to lower energy prices, these are longer term effects that may do just that.

Ok, let’s move on to the market activities in the wake of yesterday’s CPI and ahead of this morning’s PPI data.  As discussed above, yesterday’s US markets rebounded from their worst levels of the morning and closed modestly lower with the NASDAQ actually unchanged.  In Asia, Japanese shares (+1.3%) had a solid day as the weak yen helped things along although Chinese shares (HK -0.2%, CSI 300 -0.4%) did not fare as well on the day with tariffs still top of mind.  Elsewhere in the region, other than Korea (+1.4%) movement was mixed and modest.  In Europe, the possibility of peace breaking out in Ukraine has clearly got investors excited as both Germany (+1.5%) and France (+1.2%) are seeing strong inflows. The UK (-0.7%) however, continues to suffer from economic underperformance with no discernible benefits shown from the governments weak efforts to right the ship.  GDP was released this morning and while they avoided recession, it’s very hard to get excited over 0.1% Q/Q growth.  As to the US futures market, at this hour (7:20), they are essentially unchanged.

In the bond market, we’ve already discussed Treasury yields, but another benefit of the prospects for a Ukrainian peace is that sovereign yields have fallen substantially, between -5bps and -8bps, throughout the continent.  Once again, the impact of that phone call between Trump and Putin has been quite significant.  Consider that not only are energy prices likely to slide, but the required government spending to prosecute the war is likely to diminish as well.

In the commodity markets, it should be no surprise that oil (-1.3%) prices are sliding as are NatGas prices in Europe (TTF -7.5%) as the opportunity for cheap Russian gas to flow to Europe is once again in view.  To highlight the impact that this has had on Europe, prior to the Ukraine war and the halting of gas flows, the TTF contract hovered between €5 and €25 per MWh.  Since the war broke out, even after the initial shock, it has been between €25 and €55 per MWh.  This is all you need to know about why Europe, and Germany especially, is deindustrializing.  As to the metals markets, after a few days of consolidation, gold (+0.4%) is on the move again although it has not yet recaptured the highs seen early Tuesday morning.  Give it time.  Copper (+0.6%), too, is back on the move and indicating that economic activity is set to continue to grow.

Finally, the dollar is mixed this morning, although arguably a touch softer overall, as the Russia news has traders looking for less negativity in Europe.  So modest gains in the euro and pound, about 0.15% each is offsetting larger losses in AUD (-0.3%) and NZD (-0.6%), although given the much smaller market size of the latter two, they matter much less.  JPY (+0.4%) is rebounding after yesterday’s sharp decline on the back of the jump in Treasury yields, and it is noteworthy that CHF (+0.65%) is gaining after its CPI data showed a decline in prices last month.  In the EMG bloc, CLP (+0.7%) is stronger on that copper rally, while ZAR (+0.1%) seems to be edging higher as gold continues to perform well. MXN (-0.4%) though is still struggling with the potential negative impact of tariffs and otherwise, there is not much to report.

This morning brings PPI (exp 0.3%. 3.3% Y/Y headline; 0.3%, 3.5% Y/Y core) as well as the weekly Initial (215K) and Continuing (1880K) Claims data.  There are no Fed speakers on the docket, but at this point, I expect the Fed will be fading into the background since they are clearly on hold and President Trump commands the spotlight.  Unless the data starts to veer dramatically away from what we have seen, it appears that the market is going to continue to respond to Trumpian headlines, which of course are impossible to predict.  But remember, most of the rest of the world is still in cutting mode so the dollar should continue to hold its own.

Good luck

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Not in a Rush

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Said Powell, we’re not in a rush
To cut rates as we try to crush
Remaining inflation
And feel the sensation
Of drawing an inside straight flush
 
Up next is the CPI data
Though not one on which we fixate-a
The surveys explain
That people remain
Quite certain that we’re doing great-a

 

Chairman Powell testified to the Senate Banking Committee yesterday and the key comments were as follows, “Inflation has eased significantly over the past two years but remains somewhat elevated relative to our 2 percent longer-run goal. Total personal consumption expenditures (PCE) prices rose 2.6 percent over the 12 months ending in December, and, excluding the volatile food and energy categories, core PCE prices rose 2.8 percent. Longer-term inflation expectations appear to remain well anchored, as reflected in a broad range of surveys of households, businesses, and forecasters, as well as measures from financial markets.” [Emphasis added.] He followed up, “With our policy stance now significantly less restrictive than it had been and the economy remaining strong, we do not need to be in a hurry to adjust our policy stance.  We know that reducing policy restraint too fast or too much could hinder progress on inflation.”  This is largely what was expected as virtually every Fed speaker since the last FOMC meeting has said the same thing, there is no rush to further cut rates. Powell did admit that the neutral rate had risen compared to where it was before inflation took off in 2022 but maintains that current policy is still restrictive. 

However, let’s examine the highlighted comment above a little more closely.  Two things belie that statement as wishful thinking rather than an accurate representation of the current situation.  The first is that the most recent survey released from Friday’s Michigan Sentiment surveys, shows that inflation expectations for the next year jumped dramatically, one full percent to 4.3% as per the below chart.

Source: tradingeconomics.com

Looking over the past 10 years of data, that is a pretty disturbing spike, taking us right back to the 2022-23 period when inflation was roaring.  In addition to that little jump, it is worth looking at those market measures that Powell frequently mentions.  Typically, they are either the 5-year or 10-year breakeven rate.  That rate is the difference between the 5-year Treasury yield and the 5-year TIPS yield (or correspondingly the 10-year yields).  A quick look at the chart below shows that since the Fed first cut rates in September 2024, the 5-year breakeven rate has risen 78bps to 2.64%.  Certainly, looking at the chart, the idea of ‘well anchored’ isn’t the first description I would apply.  Perhaps, rocketing higher?

At any rate, it appears quite clear that the Fed is on hold for a while yet as they await both the evolution of the economy and further clarity on President Trump’s policies on tariffs.  While there is no doubt that we will continue to hear from various Fed speakers going forward, I maintain that the Fed is not seen as the primary driver in markets right now, rather that is President Trump.

Of course, data will still play a role, just a lesser one I believe, but we cannot ignore the CPI report due this morning.  First, remember, the Fed doesn’t focus on CPI, but rather on PCE which is typically released at the end of the month and calculated by the Commerce Department, not the BLS.  But the rest of us basically live in CPI land, so we all care.  If nothing else, it gives us something to complain about as we look incredulously at the declining numbers despite what we see with our own eyes every time we go shopping.

As it is, here are this morning’s median expectations for the data, headline CPI (+0.3% M/M, 2.9% Y/Y) and core CPI (+0.3% M/M, 3.1% Y/Y).  Once again, I believe there is value in taking a longer view of this data for two reasons; first to show that we are not remotely approaching the levels to which we became accustomed prior to the Covid pandemic and government response, and second to highlight that if your null hypothesis is CPI continues to decline, that may not be an appropriate view as we have spent the past 8 months in largely the same place as per the below chart.  Too, note the similarity between the Michigan Survey chart above and this one.

Source: tradingeconomics.com

OK, those are really the stories of the day since there have not, yet, been any new tariffs imposed by President Trump, and traders need to focus on something.  Let’s take a look at how things behaved overnight.

After a mixed US equity session, the strength was in Hong Kong (+2.6%) and China (+1.0%), seemingly on the back of several stories.  First is that China is looking at new ways to address the property bubble’s implosion, potentially allocating more support there, as well as this being a reflexive bounce from yesterday’s decline and the story that President’s Xi and Trump have spoken with the hope that things will not get out of hand there.  As to Japan, the Nikkei (+0.4%) has edged higher as the yen (-0.7%), despite a lot of talk about higher rates in Japan and the currency being massively undervalued, continues to weaken.  In Europe, once again there is limited movement overall with very tiny gains of less than 0.2% the norm although Spain’s IBEX (+0.7%) is the big winner today on some positive earnings results.  US futures are little changed at this hour (7:15).

In the bond market, Treasury yields are unchanged this morning, retaining the 4bps they added yesterday, and in Europe, sovereign yields are also little changed with German Bunds (+2bps) the biggest mover in the session.  JGB yields did rise 3bps overnight, but that seems to be following US yields as there was precious little new news there.

In the commodity markets, yesterday’s metal market declines are mostly continuing this morning with gold (-0.6%) down again, although still hanging around $2900/oz.  Silver has slipped although copper (+0.3%) has arrested its decline.  Oil (-1.1%) is giving back some of yesterday’s gains and continues to trade in the middle of its trading range with no real direction.  One thing I haven’t highlighted lately is European TTF NatGas prices, which while softer this morning (-1.9%) have risen 15% in the past month as storage levels in Europe are declining to concerning levels and global warming has not resulted in enough warm days for the winter.

Finally, the dollar is mixed away from the yen’s sharp decline with the euro (+0.1%) and CHF (+0.2%) offsetting the AUD (-0.3%) and NOK (-0.5%).  It is interesting that many of the financial and trading accounts that I follow on X (nee Twitter) continue to point to JPY and CAD as critical and are anticipating strength in both those currencies imminently.  And yet, neither one is showing much tendency to strengthen, at least for the past month or two.  I guess we shall see, but if the Fed is going to remain on hold, and especially if more tariffs are coming, I suspect the default direction of the dollar will be higher.  As to the EMG bloc, there is virtually nothing happening here, with a mix of gainers and laggards, none of which have moved 0.2% in either direction.

Other than the CPI data, Chairman Powell testifies to the House Financial Services Committee, and we will see EIA oil inventories with a modest build anticipated.  We also hear from two other Fed speakers, but again, with Powell in the spotlight, they just don’t matter.

Markets overall are pretty quiet, seemingly waiting for the next shoe to drop.  My money is on that shoe coming from the Oval Office, not data or Powell, which means we have no idea what will happen.  Stay hedged, but until further notice, I still don’t see a strong case for the dollar to decline.

Good luck

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Loathing and Fear

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On Friday, the jobs situation
Explained there was little causation
For loathing or fear
That later this year
Recession would soon drive deflation
 
Meanwhile, in the Super Bowl’s wake
The president’s set to forsake
Economists’ warning
That tariffs are scorning
Their views, and are quite a mistake

 

Let’s start with a brief recap of Friday’s employment report which was surprising on several outcomes.  While the headline was a touch softer than forecast, at 143K, revisions higher to the prior two months of >100K assuaged concerns and implied that the job market was still doing well.  You may recall that there were rumors of a much higher Unemployment Rate coming because of the annual BLS revisions regarding total jobs and population, but in fact, Unemployment fell to 4.0% despite an increase in the employed population of >2 million.  Generally, that must be seen as good news all around, even for the Fed because the fact that they have paused their rate cutting cycle doesn’t seem to be having any negative impacts.

Alas for Powell and friends, although a real positive for the rest of us, the Earnings data was much stronger than expected, up 0.5% on the month taking the annual result to a 4.1% increase.  Recall, one of Powell’s key concerns is non-core services inflation, and that is where wages have a big impact.  After this data, it becomes much harder to anticipate much in the way of rate cuts soon by the Fed.  This was made clear by the Fed funds futures market which is now pricing only an 8.5% probability of a rate cut in March, down from 14% prior to the data, and only 36bps of cuts all year, which is down about 12bps from before.

Securities markets didn’t love the data with both stocks and bonds declining in price, although commodities markets continue to rally alongside the dollar, a somewhat unusual outcome, but one that makes sense if you consider the issues.  Inflation is not yet dead, hurting bonds, while the fact the Fed is likely to remain on hold for longer supports the dollar.  Stocks, meanwhile, need to see more economic growth because lower rates won’t support them while commodities are seen as that inflation fighting haven.

Of course, it wouldn’t be a day ending in Y if we didn’t have another discussion on tariffs during this administration.  The word is that the president has two things in mind, first, reciprocal tariffs, meaning the US will simply match the tariff levels of other countries rather than maintaining their current, generally lower, tariff rates.  As an example, I believe the EU imposes a 10% tariff on US automobile imports, while the US only imposes a 2.5% tariff on European imports.  The latter will now rise to 10%.  It will be very interesting to see how the Europeans complain over the US enacting tariffs that are identical to their own.  

A side story that I recall from a G-20 meeting during Trump’s first term was that he offered to cut tariffs to 0% for France if they reciprocated and President Macron refused.  The point is that while there is a great deal of huffing and puffing about free trade and that Trump is wrecking the world’s trading relationships, the reality appears far different.  If I had to summarize most of the world’s view on trade it is, the US should never put tariffs on any other country so they can sell with reckless abandon, while the rest of the world can put any tariffs they want on US stuff to protect their home industries.  This is not to say tariffs are necessarily good or bad, just that perspective matters.

The other Trump tariffs to be announced are on steel and aluminum imports amounting to 25% of the value. This will be impactful for all manufacturing industries in the US, at least initially, so we will see how things progress.  Interestingly, the dollar has not responded much here because these are not country specific, so a broad rise in the dollar may not be an effective mitigant.

Ultimately, as I have been writing for a while, volatility is the one true change in things now compared to the previous administration.  Now, with that as backdrop, and as we look ahead to not only CPI data on Wednesday, but Chair Powell’s semi-annual congressional testimony on Tuesday at the Senate and Wednesday at the House, let’s look at how markets have responded to things.

As mentioned above, US equity markets fell about -1.0% on Friday after digesting the Unemployment data. However, the picture elsewhere, especially after these tariff discussions, was more mixed.  In Asia, Japanese shares were essentially unchanged although Hong Kong (+1.8%) was the big winner in the region.  But Chinese shares (+0.2%) did little, especially after news that the number of marriages in China fell to their lowest since at least 1986, another sign of the demographic decline in the nation.  Elsewhere in the region, there was more red (India, Taiwan, Australia) than green (Singapore).  European shares, though, are holding up well, with modest gains of about 0.2% – 0.4% across the board despite no real news.  US futures are also ticking higher at this hour (7:10), about 0.5% across the board.

In the bond market, Friday saw Treasury yields jump 6bps with smaller gains seen in Europe.  This morning, though, the market is far quieter with Treasury yields unchanged and European sovereigns similarly situated, with prices between -1bp and +1bp compared to Friday’s closing levels.  Of note, JGB yields have edged higher by 1bp and now sit at 1.31%, their highest level since April 2010.  With that in mind, though, perhaps a little bit of longer-term perspective is in order.  A look at the chart below shows 10-year JGB yields and USDJPY since 1970.  Two things to note are that they have largely moved in sync and that both spent many years above their current levels.  While it has been 15 years since JGB yields were this high, they are still remarkably low, even compared to their own history.  I know that many things have changed over that time driving fundamentals, but nonetheless, this cannot be ignored.

Source: tradingeconomics.com

Sticking with the dollar, it has begun to edge higher since I started writing this morning and sits about 0.2% stronger than Friday’s close.  USDJPY (+0.5%) is once again the leader in the G10, although weakness is widespread in that bloc.  In the EMG bloc, there were a few gainers overnight (INR +0.3%, KRW +0.3%) although the rest of the world is mostly struggling.  One interesting note is ZAR (0.0%) which appears to be caught between the massive rally in gold (to be discussed below) and the increased rhetoric about sanctions by the US in the wake of the ruling party’s ostensible call for a genocide of white South Africans to take over their property.  This has not been getting much mainstream media press, but it is clear that Mr Trump is aware, especially given that Elon Musk is South African by birth.  However, there is no confusion in the South African government bond market, which, as you can see below, has seen yields explode higher in the past week since this story started getting any press at all.

Source: tradingeconomics.com

Finally, the commodity markets continue to show significant movement, especially the metals markets.  Gold (+1.6%) is now over $2900/oz, another new all-time high and calling into question if this is just an arbitrage between London and New York deliveries.  Silver (+1.4%) continues to be along for the ride as is copper (+0.6%) which is the biggest gainer of the past week, up more than 7%.  Ironically, aluminum, the only metal where tariffs are involved, is actually a touch softer this morning.  As to oil (+1.2%) while the recent trend remains lower, it does appear to be bottoming, at least if we look at the chart below.

Source: tradingeconomics.com

Turning to the data this week, it will be quite important as CPI headlines, but we also see Retail Sales and other stuff and have lots of Fedspeak.

TuesdayNFIB Small Biz Optimism104.6
 Powell Testimony to Senate 
WednesdayCPI0.3% (2.9% Y/Y)
 -ex food & energy0.3% (3.1% Y/Y)
 Powell Testimony to House 
ThursdayPPI0.3% (3.4% Y/Y)
 -ex food & energy0.3% (3.3% Y/Y)
 Initial Claims216K
 Continuing Claims1875K
FridayRetail Sales-0.1%
 -ex autos0.3%
 IP0.2%
 Capacity Utilization77.7%

Source: tradingeconmics.com

In addition to Powell, we will hear from five more Fed speakers, although with Powell speaking, I imagine their words will largely be ignored.  Overall, the world continues to try to figure out how to deal with Trump and his dramatic policy changes from the last administration.  One thing to keep in mind is that so far, polls show a large majority of the nation remains in support of his actions so it would be a mistake to think that his policy set is going to be altered.  Net, the market continues to believe this will support the dollar, as will the fact that the Fed seems less and less likely to start cutting rates soon.  Keep that in mind as you consider your hedges going forward.

Good luck

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Positioning’s Fraught

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The wonderful thing about Trump
Is traders no longer can pump
A market so high
That it can defy
Reality ere it goes bump
 
Since policies can change so fast
A long-term view just cannot last
So, Fed put or not
Positioning’s fraught
And larger ones won’t be amassed

 

As we await the NFP report this morning, I couldn’t help but ponder the uptick in complaints and concerns by traders that increased volatility in markets on the back of President Trump’s mercurial announcements has changed the trading game dramatically.  Let me say up front that I think this is a much healthier place to be and explain why.

Pretty much since the GFC and, more importantly, then Chairman Bernanke’s first utilization of QE and forward guidance, the nature of financial markets had evolved into hugely leveraged one-sided views based on whatever the Fed was guiding.  So, the initial idea behind QE and forward guidance was to assure all the traders and investors that make up the market that even though interest rates reached 0.0%, the Fed would continue to ease policy and would do so for as far out in time as you can imagine.  Lower for longer became the mantra and every time there was a hiccup in the market, the Fed rushed in, added yet more liquidity to calm things down, and put the market back on track for further gains.  This was true for both stocks and bonds, despite the fact that the Fed has no business or mandate involving the equity market.

This activity led to the ever-increasing size of trading firms as leverage was cheap and steadily rising securities prices led to lower volatility, both implied and real, in the markets.  Risk managers were comfortable allowing these positions to grow as the calculated risks were minimized by the low vol.  In fact, entire trading strategies were developed to take advantage of the situation with Risk Parity being a favorite.  

However, a negative result of these actions by the Fed was that investors no longer considered the fundamentals or macroeconomics behind an investment, only the Fed’s stance.  The only way to outperform was to take on more leverage than your competitors, and that was great while rates stayed at 0.0%.  Alas, this persisted for so long that many, if not most, traders who learned the business prior to the GFC wound up retiring or leaving the market, and the next generation of traders and investors lived by two credos, number go up and BTFD.

The Fed remained complicit in this process as FOMC members evolved from background players to a constant presence in our daily lives, virtually preening on screens and in front of audiences and reiterating the Fed’s views of what they were going to do, implicitly telling traders that taking large, leveraged bets would be fine because the Fed had their back.

Of course, the pandemic upset that apple cart as the combination of Fed and government response imbued the economy with significantly more inflation than expected and forced the Fed to change their tune.  The market was not prepared for that, hence the outcome in 2022 when both stocks and bonds fell sharply.  But the Fed would not be denied and calmed things down and created a coherent enough message so that markets recovered the past two years.  This has, naturally, led to increased position sizing and more leverage because that’s what this generation of traders understands and has worked.

Enter Donald J Trump as president, elected on a populist manifesto and despite his personal wealth, seemingly focused on Main Street, not Wall Street.  The thing about President Trump is if an idea he proffers doesn’t work, he will drop it in a heartbeat and move on.  As well, by wielding the full power of the United States when dealing in international situations, other nations can quickly find themselves in a difficult spot and, so far, have been willing to bend their knee.  As well, his focus on tariffs as a primary weapon, with little regard for the impact on markets, and the way with which he uses them, threatening to impose them, and holding off at the last minute when other nations alter their policy, has kept markets off-balance.

The result is large leveraged positions are very difficult to hold and manage when markets can move up and down 2% in a day, every day (like the NASDAQ 100 chart below), depending on the headlines.  

Source: tradingeconomics.com

The natural response is to reduce position size and leverage, and that, my friends, is a healthy turn in markets.  This is not to say that there are not still many significant imbalances, just that as they continue to blow up, whether Nvidia, or FX or metals, my take is the next set of positions will be smaller as nimble is more important than large.  It doesn’t matter how smart an algorithm is if there is no liquidity to adjust a position when the world changes.  This poet’s opinion is this is a much healthier place for markets to live.

Ok, let’s see what happened overnight ahead of today’s data.  Mixed is the best description as yesterday’s US closes saw a mixed outcome and overnight the Nikkei (-0.7%) fell while both Hong Kong (+1.2%) and China (+1.3%) gained ground.  Korea and India slid, Taiwan rose, the picture was one of uncertainty about the future.  That also describes Europe, where only Germany and Norway have managed any modest gains at all while the rest of the continent and the UK are all slightly lower.  Apparently, yesterday’s BOE rate cut has not comforted investors in the UK, nor has the talk of more rate cuts by the ECB bolstered attitudes in Europe.  As to US futures, at this hour (7:00) they are basically unchanged.

In the bond market, the biggest mover overnight was in Japan where JGB yields rose 3bps, once again touching that recent 30-year high.  While some BOJ comments indicated inflation remained well-behaved, the market is clearly of the view that Ueda-san is getting set to hike rates further.  In Europe, yields are basically lower by 1bp across the board and Treasury yields are unchanged on the session as investors and traders continue to focus on Treasury Secretary Bessent’s conversation that he cares about 10-year yields, not Fed funds.  Perhaps the Fed will cut rates to recapture the spotlight they have grown to love.

Oil (+0.5%) prices continue to drift lower overall, although this morning they are bouncing from yesterday’s closing levels.  Questions about sanctions policy on Iran, on Russia’s shadow fleet and about the state of the global economy and therefore oil demand remain unanswered.  However, the fact that oil has been sliding tells me that there is some belief that President Trump may get his way regarding a desire for lower oil prices.  In the metals markets, copper (+1.1%) is flying higher again, and seems to be telling us that the economy is in decent shape.  Either that or there is a major supply shortage, although if that is the case, I have not seen any reporting on the subject.  Both gold and silver are very modestly higher this morning after small declines yesterday as the London – NY arbitrage continues to be the hot topic and financing rates for both metals have gone parabolic.

Finally, the dollar is mixed this morning, perhaps slightly firmer as JPY (-0.5%) is actually the worst performer around, despite the rise in JGB yields.  There is a lot of chatter on how the yen is due to trade much higher, and it has rallied over the past month, but it is certainly not a straight line move.  As to the rest of the space, virtually every other currency is +/-0.2% from yesterday’s close with CLP (+0.5%) the lone exception as the Chilean peso benefits from copper’s huge rally.

On the data front, here are the latest expectations for this morning’s employment report:

Nonfarm Payrolls170K
Private Payrolls141K
Manufacturing Payrolls-2K
Unemployment Rate4.1%
Average Hourly Earnings0.3% (3.8% Y/Y)
Average Weekly Hours34.3
Participation Rate62.5%
Michigan Sentiment71.1

Source: tradingeconomics.com

Remember, though, the ADP number on Wednesday was much better than expected at 183K (exp 150K) with a major revision higher by 54K to the previous month).  As well, this month brings the BLS adjustments for 2024 which will not be broken down, just lumped into the data.  Recall, there are rumors of a significant reduction in the number of jobs created in 2024 as well as a significant increase in the population estimates with more complete immigration data, and that has led some pundits to call for a much higher Unemployment Rate.  I have no insight into how those adjustments will play out although the idea they will be large seems highly plausible.

Ahead of the number, nothing will happen.  If the number is strong, so NFP >200K, I expect that bonds will suffer, and the dollar will find some support.  A weak number should bring the opposite, but the revisions are a wild card.  As I stated this morning, the best idea is to maintain the smallest exposures possible for the time being, as volatility is the one thing on which we can count.

Good luck and good weekend

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Three-Three-Three

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Said Bessent, when speaking of rates
The 10-year yield’s what dominates
Our focus and goals
As that’s what controls
Most mortgages here in the States
 
Remember, our goal’s three-three-three
With job one on deficits key
So, that’s why we’ll slash
The wasting of cash
With tax cuts set permanently

 

There is a new voice in Washington that matters to Wall Street, that of the new Treasury Secretary Scott Bessent.  Yesterday in his first significant comments since his swearing-in, he made very clear that he and the president were far more focused on the 10-year Treasury yield, and driving that lower, than they were concerned over the Fed funds rate.  Talk about a different focus than the last administration!  At any rate, he expounded on his views as to how that can be achieved, namely lower energy prices and a reduced budget deficit alongside deregulation.  Recall, his three-three-three plan is 3% budget deficit, 3mm barrels of oil/day additional supply and 3% GDP growth.  Clearly, this is a tall order given the starting point, but he has not shied away from these goals and insists they are achievable.

Yesterday also brought the Quarterly Refunding Announcement, the Treasury’s announced borrowing schedule for the current quarter.  Under then-Secretary Yellen, the US shifted its borrowing to a much greater percentage of short-term T-bills (<1-year maturity) while avoiding the sale of longer date notes and bonds.  This is something which Bessent has consistently explained his predecessor screwed up given her unwillingness to term out more debt when the entire interest rate structure was much lower.  After all, homeowners were smart enough to refinance down to 3% fixed rate mortgages, but the Treasury secretary thought it was a better idea to stay short.  

Of course, changing the current treasury mix is one of the impediments to lower 10-year yields because changing it would require an increase in the sale of longer dated paper which would depress the price and raise those yields.  Bessent has his work cut out for him.  However, my take is this is a goal, but one that will be achieved gradually.  He even commented that until the debt ceiling is raised, there will be no changes in the debt mix.  Arguably, if the administration can make real progress on reducing the budget deficit, that is what will allow for the gradual adjustment of the debt mix without a dramatic rise in long-term yields.

Perhaps it is still the honeymoon period, but the market is showing some deference to Mr Bessent as 10-year yields have fallen steadily in the past two weeks, dropping from a high of 4.81% the week before the inauguration to their current level at 4.44%.  

Source: tradingeconomics.com

While we cannot attribute the entire move to Bessent, certainly investors are showing at least a little love at this stage.  I believe the 10-year yield will grow in importance for all markets as movement there will be seen as the report card for Bessent and this administration’s goals.

Meanwhile, in the UK, stagflation
Is now the Old Lady’s vexation
But cut rates, they will
Lest growth they do kill
As prices continue dilation

The BOE is currently meeting, and expectations are nearly universal that they will cut their base rate by 25bps to 4.50% with 8 of the 9 MPC members set to vote that way.  The only hawk on the committee, Catherine Mann, is expected to vote for no change.  The problem they have (well the problem regarding monetary policy, there are many problems extant in the UK right now) is that core inflation continues to run above 3.0% while GDP is growing at approximately 0.0% in recent quarters and at 1.0% in the past year.  A quick look at the monthly GDP readings below shows that things have not been moving along very well, certainly not since PM Starmer’s election in July.

Source: tradingeconomics.com

In stagflationary environments, the most successful central bank responses have been to kill the inflation and suffer the consequences of the inevitable recession first, allowing growth to resume under better circumstances.  Of course, Paul Volcker is most famous for this model, which he derived after numerous other countries, notably the UK, failed to effectively solve the problem in the mid 1970’s in the wake of the first oil price shocks.  Now, the UK has created its own energy price supply shock via its insane efforts to wean itself from fossil fuels without adequate alternate supplies of energy, and stagflation is the natural result.  However, addressing inflation does not appear to be the primary focus of the Bank of England right now.  I am skeptical that they will be successful in achieving their goals which is one of the key reasons I dislike the pound over time.

Ok, let’s turn to market activity overnight.  The party continues on Wall Street with yesterday’s equity gains attributed to many things, perhaps Bessent’s comments being amongst the drivers.  Certainly, a reduced budget deficit and reduced 10-year yields are likely to help the market overall.  That attitude has been uniform overnight and through the morning session with every major Asian market (Japan, +0.6%, Hong Kong +1.4%, China +1.3%) and European market (Germany +0.8%, France +0.8%, UK +1.45%) higher on the session.  As it happens, the BOE did cut rates by 25bps as expected and now we await Governor Bailey’s comments.  As to US futures, at this hour (7:25) they are little changed on the session.

In the bond market, the ongoing rally has stalled for now with Treasury yields higher by 2bps this morning while most European sovereign yields are little changed on the day.  A key piece of information that is set to be released tomorrow comes from the ECB as their economists are going to report the ECB’s estimate of where the neutral rate lies in Europe.  With the deposit rate there down to 2.75%, many pundits, and ECB speakers, are targeting 2.0% as the proper level implying more rate cuts to come.

In the commodity markets, oil (+0.65%) is bouncing off its recent trading lows but in truth, a look at the chart and one is hard-pressed to discern an overall direction.  More choppiness seems likely as the market tries to absorb the latest information from the Trump administration and its plans.

Source: tradingeconomics.com

As to the metals markets, gold, which had a strong rally yesterday and made further new all-time highs, is unchanged this morning while silver (-0.75%) consolidates its recent gains and copper (+0.6%) adds to its gains.  The thing about copper is it is, allegedly, a good prognosticator of economic activity as it is so widely used in industry and construction, and it has been rallying sharply for the past month.  That does seem to bode well for future activity.

Finally, the dollar is firmer this morning, recouping some of its recent losses although I would contend we have merely been consolidating after a sharp move higher during the past three months.  The pound (-1.0%) is today’s laggard after the rate cut but we are seeing weakness almost everywhere in both G10 and EMG currencies.  One exception is the yen (+0.2%) which seems to be benefitting from comments by former BOJ Governor Kuroda that the BOJ is likely to raise rates above 1.0% during the coming year.  Interestingly, he explained that given the recent economic trajectory, it was only natural that the BOJ would seek to normalize rates.  However, given that interest rates in Japan have been 0.5% or below for the past 30 years, wouldn’t that be considered normal these days?  Just sayin’!

On the data front, with the BOE out of the way, we now get the weekly Initial (exp 213K) and Continuing (1870K) Claims data as well as Nonfarm Productivity (1.4%) and Unit Labor Costs (3.4%).  Yesterday’s ADP Employment data was much stronger than expected with a revision higher to last month as well, certainly a positive for the job outlook.  As well, this afternoon we hear from three more Fed speakers, but so far this week, the word caution has been the most frequently used noun in their vocabulary.  Of course, with Mr Bessent now starting to make his views known, perhaps more focus will turn there and away from the Fed for a while.

Market participants are clearly feeling pretty good right now, especially about the recent activity in the US.  I think you have to like US assets, both stocks and bonds, while expecting the dollar to continue to hold its ground.  This sounds like a recipe for weaker commodity prices, notably gold, but so far, that has not been the case.

Good luck

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Is Past Prologue?

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The Japanese tale
Now sees brighter times ahead
Yen buyers rejoice

 

While its movement has been somewhat choppy, for the past month, the yen has been the best performing currency in the G10, gaining more than 3.0% during that time.  This strength seems to have been built on several different themes including a more hawkish BOJ, better growth prospects based on PMI data, rising wages, and some underlying risk aversion.  A quick look at the chart shows that the trend is clearly lower and there have been far more down days for the dollar than up days during this period.

Source: tradingeconomics.com 

Of course, as I regularly remind myself, and you my good readers, perspective is an important thing to keep in mind, especially when making statements about longer term prospects of a currency.  When looking at USDJPY over a longer term, say the past 5 years where long-term trends have been entrenched based on broad macroeconomic issues as well as the day-to-day vagaries of trading, the picture looks quite different.  In fact, as you can see from the below chart, the past month’s movement barely registers.

Source: tradingeconomics.com

My point is that we must be careful regarding the relative importance of information and news and keep in mind that short-term movements may very well be just that, short-term, rather than major changes in long-term trends.  The latter require very significant macro changes regarding interest rate policy and economic activity, at least when it comes to currencies, not simply a single central bank policy move.

So, the question at hand is, are we at the beginning of a major set of policy shifts that will change the long-term trajectory of the yen?  Or is the yen’s recent strength merely normal noise?

While almost everybody has their own opinion on how the Fed is going to proceed going forward, I think it is instructive to look at the Fed funds futures market and the pricing for future rate activity.  For instance, a look at the current market, especially when compared where these probabilities were one month ago tells us that expectations for Fed rate cuts have diminished pretty substantially, arguably implying that there is more reason to hold dollars.

Source: CME.org

You can see in the lower right-hand corner of the chart that the probability of a rate cut has fallen from nearly 44% to just 16.5% over the past month.  However, during that same period, the BOJ has not only raised interest rates by 25bps, but they have made clear that further rate hikes are coming based on wage settlements and sticky inflationary readings.  One potential way to incorporate this relative movement is to look at the change in forecast interest rates, which in the US have risen by ~7bps (27% *25bps) while Japanese interest rates have risen by 25bps with expectations for another 25bps coming soon.  That is a powerful incentive to be long yen or at least less short yen, than previous positioning.  And we have seen that play out as the yen has strengthened as per the above.

The real question is, can we expect this to continue?  Or have we seen the bulk of the movement?   Here, much will depend on the future of the Fed’s actions as the market is seeing a bifurcation between those who believe rates are destined to fall further once inflation starts to ease again, vs. those, like this poet, who believe that inflation is showing no signs of easing, and therefore the Fed will be hard-pressed to justify further rate cuts.  While I am not the last word on the BOJ, from every source I see, expecting their base rate to be raised above 1.00% anytime in the next several years is aggressive.  Just look at the below chart showing the history of the BOJ base rate.  The last time the rate was above 0.50%, its current level, was September 1995.  That is not to say they cannot raise it, just that as you can see, several times in the intervening years they tried to do so and were forced to reverse course as the economy fell back into the doldrums with inflation quickly falling as well.  

Source: tradingeconomics.com

Is past prologue?  Personally, my take is above 1.0% is highly unlikely any time in the next several years.  Meanwhile, if inflation remains the problem it is in the US, Fed cuts will be much harder to justify.  This is not to say that the yen cannot strengthen somewhat further, but I am not of the opinion we have had a sea change in the long-term trend.

Ok, after spending way too much time on the yen, given that there hasn’t even been any tariff discussion on Japanese products, let’s look elsewhere to see how things moved overnight.

Yesterday saw further relief by equity investors that tariffs are a key Trump negotiating tactic rather than an effort to raise revenue and US markets all gained, especially the NASDAQ.  However, the movement in Asia was more muted with the Nikkei (+0.1%) barely higher while both Hong Kong (-0.9%) and China (-0.6%) fell amid the Chinese tariffs remaining in place.  As to the regional markets, there were some notably gainers (Korea and Taiwan), but away from those two a more mixed picture with less absolute movement was the order of the day.  In Europe, Spain’s IBEX (+1.0%) is the standout performer after the PMI data showed only a modest slowing, and a much better result than the rest of the continent.  Perhaps this explains why the rest of the continent is +/- 0.2% on the session.  As to US futures, they are lower at this hour (7:30) on the back of weaker earnings data from Google after the close last night.

In the bond market, yields have fallen across the board (except in Japan where JGB yields made a run at 1.30%) with Treasury yields lower by 4bps this morning and 12bps from the highs seen yesterday morning.  European sovereign yields are all lower as well, between -4bps and -7bps, as the weaker PMI data has traders convinced that the ECB is going to respond to weakening growth rather than sticky inflation and are now pricing in 100bps of cuts this year with the first 25bps coming tomorrow.

In the commodity space, gold (+1.0%) is the god of commodities right now, rallying more than $100/oz over the past five sessions.  There continue to be questions as to whether this is a major short squeeze as COMEX contracts come up for delivery, but it is not hard to write a narrative that there is increased uncertainty in the world and gold is still seen as the ultimate safe haven.  This gold rally continues to pull other metals higher (Ag +0.8%, Cu +0.2%) although I have to believe this is going to come to a halt soon.  Meanwhile, energy prices have fallen again (oil -1.0%, NatGas -1.5%) as fears over supply issues have dissipated completely.

Finally, the dollar is under pressure overall, certainly one of the reasons the yen (+1.0%) has performed so well overnight, but elsewhere in the G10, we are seeing the euro, pound and Aussie all gain 0.4% or so.  In the EMG bloc, CLP (+1.0%) is gaining on that renewed copper strength while ZAR (+0.5%) is shaking off the Trump threats regarding recent legislative changes and benefitting from gold’s massive rally.  The one outlier is MXN (-0.4%) which seems to be caught between the benefits of stronger silver prices (Mexico is a major exporter of silver) and weaker oil prices.

On the data front today, we start with ADP Employment (exp 150K) then the Trade Balance (-$96.6B) and get ISM Services (54.3) at 10:00.  We also see the EIA oil inventory data with a modest build anticipated across all products.  Four more Fed speakers are on the docket but as we continue to hear from more and more of the FOMC, the word of the moment is caution, as in, the Fed needs to move with caution regarding any further rate cuts.

I don’t blame the Fed for being cautious as President Trump has the ability to completely change perspectives with a single announcement.  While yesterday was focused on Gaza, not really a financial market concern, who knows what today will bring?  It is for this reason that I repeatedly remind one and all, hedging is the best way to moderate changes in cash flows and earnings, and consistent programs, regardless of the situation on a particular day, are very valuable.

Good luck

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Not in a Hurry

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Said Powell, we’re not in a hurry
To cut after last year’s late flurry
Instead, wait and see
Is likely to be
The future lest ‘flation hawks worry

 

The opening paragraph of the FOMC Statement was concise as they acknowledge that things aren’t too bad right now.  “Recent indicators suggest that economic activity has continued to expand at a solid pace. The unemployment rate has stabilized at a low level in recent months, and labor market conditions remain solid. Inflation remains somewhat elevated.”  

Of course, that didn’t stop Chairman Powell from still describing rates as restrictive or “meaningfully above” the neutral rate, although in fairness, he did explain “We do not need to be in a hurry to adjust our policy stance.”  When asked about the impact of President Trump’s mooted policies regarding tariffs and trade, he explained, “The committee is very much in the mode of waiting to see what policies are enacted. We need to let those policies be articulated before we can even begin to make a plausible assessment of what their implications for the economy will be.”

In the end, I don’t believe very much changed with respect to expectations for the Fed with the futures market still pricing in a total of 46 basis points of cuts for the rest of the year with just an 18% probability of a cut in March.  Certainly, nothing we heard or saw today changed my view of rates remaining here and potentially going higher before the end of 2025.  But for now, I don’t think there is much else to say on the subject.

In Europe, the data was bleak
As growth there remains awful weak
Today they’ll cut rates
And on future dates
A base rate much lower they’ll seek

As we await the ECB’s meeting announcement later this morning, where Madame Lagarde is virtually certain to cut their interest rate structure by 25bps, we were entertained by GDP data from the Eurozone as well as several of its members.  The numbers were disappointing even compared to weak forecasts.  For instance, in Q4, France (-0.1%) and Germany (-0.2%) both saw declining activity while Italy (0.0%) managed to not fall.  Not surprisingly, the Eurozone, as a whole, also saw a result of 0.0% GDP growth in Q4.  In every case, the annual number is below 1.0%.  Of course, if just looking at this data, it would be easy to say the ECB needs to cut rates further.  However, inflation remains uncomfortably higher than target and as evidenced by Spanish data this morning, showing it rose to 3.0% Y/Y in January, Madame Lagarde cannot ignore the sole ECB mandate of stable prices at 2.0%.

Under the rubric a picture is worth a thousand words, I think the chart below of quarterly GDP activity in Germany and the Eurozone speak volumes of how things are progressing on the continent. 

Source: tradingeconomics.com

The current policy mix in Europe is clearly not getting the job done, assuming the job is to grow the economy in a non-inflationary manner.  While the ECB can continue to cut rates in their effort to support growth, the problems on the continent have far more to do with energy policy than anything else.  The focus on ending the use of fossil fuels has resulted in the highest energy costs of any region which has led to the steady deindustrialization of the continent.  It doesn’t really matter where interest rates are if companies cannot power their operations and that is the crux of the ECB’s problems.  No matter what Lagarde and her friends do, it cannot reverse this decline.  If you were wondering why so many, including this poet, are negative on the euro’s prospects going forward, this is it in a nutshell.

Ok, let’s turn to the overnight market activity.  First, a moment’s thought for the tragedy that took place in Washington DC last night where a commuter jet collided with a military helicopter near Reagan National Airport.  As I write, it is not known how many fatalities occurred, but the word is there were 60 passengers plus crew on board the plane and 4 on the helicopter.

Yesterday’s US session was less positive than many had hoped with the specter of DeepSeek still haunting many investors but the situation in Asia was a bit more upbeat with the Nikkei (+0.25%) and Australia (+0.55%) both showing gains.  I read an entire X post as to why the next Chinese stimulus package was really going to change things and support the economy there although I continue to remain skeptical. (As an aside, it is Chinese New Year, the year of the snake, so markets in China and Hong Kong are closed for a few days.). Meanwhile, in Europe, all markets are higher as traders anticipate not only today’s ECB rate cut, but clearly more in the future as economic activity continues to wane.  So, gains across the board of between 0.35% (DAX) and 0.7% (IBEX).  US futures, too, are higher this morning, up by 0.4% at this hour (6:50).

In the bond market, yields are sliding as Treasuries (-3bps) are sitting right on 4.50% after Chairman Powell seemed to indicate they actually do care about inflation.  Meanwhile, European sovereign yields are all lower by between -6bps and -7bps ahead of the ECB announcement and responding to the weak GDP data.  Clearly, investors on the continent are convinced there are more rate cuts coming.  On the other side of that rate coin, JGB’s saw yields climb 2bps as Deputy BOJ Governor Himino indicated that further rate hikes would be appropriate given Japanese real interest rates remain negative.  Not only did that support JGB yields, but the yen (+0.5%) was also a beneficiary.  Finally, I would be remiss to ignore the Brazilian central bank, which hiked rates 100bps last night, taking their SELIC rate to 13.25%!  (And equity investors in the US complain rates are too high!)

In the commodity space, oil (-0.1%) is little changed this morning although remains near the bottom of its recent trading range.  There is so much discussion regarding what will happen here, whether Trump will be able to encourage more drilling in the US, how OPEC is going to respond to both Trump and the market, and what is going to happen in the Russia/Ukraine war, that it is very difficult to get a good handle on things.  Nothing has changed my long-term view that there is plenty of oil around and it is a political decision, not a technical nor geological one, that will determine the price.  As to metals markets, gold (+0.65%) continues to perform well and edges closer to the all-time high levels reached back in late October.  There is much discussion about the arbitrage between COMEX and LME gold with many deliveries apparently due in NY and not enough 100toz bars available.  This may be driving prices higher as those with short positions scramble to either roll their positions are get ready for delivery.  As to silver (+0.4%) and copper (+0.2%), they are both along for the ride.

Finally, the dollar is mixed this morning as while it is modestly stronger vs. some G10 counterparts (EUR -0.2%, SEK -0.2%), the yen’s strength is moderating the overall movement.  Versus its EMG counterparts, BRL (-0.8%) is the most notable mover as traders take profit after the BCB’s rate hike last night.  It was widely assumed to occur and real rates in Brazil are now nearly 9%, a very attractive level that has helped the currency appreciate more than 6% in the past month.  However, elsewhere, the movement is basically random.

On the data front, aside from the ECB rate decision, we see the weekly Initial (exp 220K) and Continuing (1890K) Claims data and the first look at Q4 GDP (exp 2.6%). Yesterday’s Goods Trade Balance was a record deficit of -$122.1 Billion as it appears many companies were ordering stuff to get ahead of the threatened tariffs.  Also, yesterday the BOC cut rates by 25bps, as widely expected, but nobody really noticed.  With the Fed sidelined for now, I suspect that we will continue to follow the equity stories more closely than the macro ones, although we do see PCE tomorrow, so a big surprise there could certainly impact the narrative.  But for now, it remains difficult to be too bearish the dollar.

Good luck

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Stardom is Fleeting

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Remarkably few people care
That Jay and the Fed will soon share
Their latest impressions
On growth and recessions
An outcome, of late, that’s quite rare
 
Does this mean that ere the next meeting
There will be an increase in bleating
By every Fed speaker
Each one a fame seeker
As they realize stardom is fleeting?

 

I wonder how the atmosphere in the meeting room at the Marriner Eccles building has changed today vs. what it has been for the past decade at least.  Usually, the FOMC meets, and financial markets are riveted by the potential and then everything comes to a virtual standstill as traders and investors await the wisdom of the Fed Chair to help determine where markets are likely to go.  I am reminded of the crop report scene in Trading Places, where the entire pit stops to watch the news and then springs back into action. 

One of the consequences of this evolution is that every member of the FOMC feels it is their duty to reiterate their views as frequently as possible, whether they are changing or not, because they are trying to increase their profile to ensure a lucrative future gig want to make sure that the American people understand just how much the Fed is doing to help them and the nation.  This is why for the first four weeks after a Fed meeting, virtually every day we have at least one if not two or three FOMC members repeating themselves ad nauseum.

But suddenly, they have real competition for airtime.  President Trump, no shrinking violet he, is incredibly adept at forcing all the world’s attention on himself, to the exclusion of formerly important voices like Alberto Musalem or Lisa Cook.  Now, the fact that you can probably not remember who those two people are is exactly my point.  FOMC members speak constantly, but it is the office, not the voice, to which people are listening.  And right now, fewer and fewer people are listening to the Fed because President Trump is commanding all the attention.  In fact, to the extent the Fed is discussed, it is generally in relation to how they are going to respond to Trump’s next moves.

But, in an effort to maintain our focus on markets and not politics, to the extent that is possible right now, the Fed still has a role to play in both expectations of how things are going to evolve as well as actual pricing.  A quick summation of where we have been with Powell and friends is that last year, starting in September they cut rates for the first time in nearly two years and have since reduced the Fed funds rate by 100bps.  A key issue here is the fact that the economy is showing no signs of slowing down, unemployment remains modest at best, and inflation has been, at best, bottoming well above their 2.0% target, if not rising again.  Hence, there have been many questions as to why they cut rates at all.

At this point, though, the Fed’s narrative prior to the quiet period, was one of increased caution that further rate cuts may not be necessary, or certainly not imminent, given the ongoing positivity in the economic situation.  As such, there is no expectation for a rate cut today, and according to the Fed funds futures market, only a 30% probability of a March cut, with basically two full cuts priced in for all of 2025.  I would argue that based on the data we have seen, it is not clear why there would be any further cuts, and, in fact, believe that by mid-year, we are likely to start to hear talk of a rate hike before the end of the year.  This will be dependent on the data, but if inflation continues to remain sticky (see chart of Core PCE below), the bar for cuts will move higher still.  Certainly, to my non-PhD trained eye, it doesn’t really look like their key metric is declining anymore.

Source: tradingeconomics.com

Perhaps the most remarkable thing about this Fed meeting is that I have seen virtually nothing regarding expectations of how the statement may change or forecasts may change.  FWIW, which is probably not much, my take is the statement will be virtually identical given no real changes in the data trends, and that Chairman Powell will go out of his way to say absolutely nothing at the presser, especially when asked about President Trump and his policies.  Of course, this will not prevent the cacophony of Fedspeak that will come between now and the next meeting, but there may be fewer folks paying attention.

Ok, let’s turn to markets.  While Monday was a tech stock rout, yesterday was the reverse with the NASDAQ shaking off the DeepSeek fears or actually embracing them based on Jevon’s Paradox (the idea that the more efficient something becomes, the greater the need/desire for it and therefore the increase in its price) leading to the new narrative that Nvidia’s chips will be in more demand.  But regardless, everybody was happier!  Asian markets responded with the Nikkei (+1.0%) regaining some luster on the tech story as well as the weaker JPY, which saw the dollar rally a full yen on the session, although it is little changed overnight.  While not universal, there was a lot more green than red in Asia, although Chinese shares (-0.4%) did not participate.

In Europe, most bourses are showing gains this morning although the CAC (-0.3%) is lagging after luxury goods makers saw weaker growth than expected.  But the DAX (+0.75%) and IBEX (+1.0%) are both stronger as is the FTSE 100 (+0.3%) as Chancellor Reeves continues to try to explain that growth is Labour’s goal despite all their policies that seem to point in the other direction.  As to US futures, at this hour (7:30) they are higher led by the NASDAQ (+0.5%).

In the bond market, the fear from Monday is gone although the bounce in yields was modest yesterday and this morning Treasury yields are unchanged on the session.  I suspect that there is some waiting for the Fed involved here.  European sovereign yields, though, are all a bit lower, down between -2bps and -3bps, as investors anticipate tomorrow’s ECB rate cut and are looking for a dovish message going forward.

In the commodity space, yesterday modest rebound in oil (-0.6%) is being reversed this morning while NatGas (0.0%) is consolidating after a dramatic decline in the past week of more than 20% given the latest weather models are now calling for much warmer temperatures in the northern hemisphere.  In the metals markets, gold (-0.2%) is consolidating yesterday’s gains as is silver (+0.2%) and copper (-0.1%).  For now, these are not all that interesting.

Finally, in the FX markets, the dollar continues to regain momentum higher with the euro (-0.3%) sliding back below 1.04 this morning and the DXY (+0.2%) back above 108.00.  However, looking across both the G10 and EMG blocs, while the dollar’s strength is widespread, it is not dramatic, with AUD (-0.5%) and PLN (-0.5%) the biggest movers of the session.  It should be no surprise that there is confusion here given the uncertainty sown by President Trump and his tariff discussions.

On the data front, the only numbers today, aside from the FOMC meeting and the BOC meeting (expected 25bp cut) is the Goods Trade Balance (exp -$105.4B).  We also get the EIA oil data with inventory builds anticipated.  But really, despite the seeming lack of interest leading up to today’s FOMC meeting, it is the only game in town.  To me, the risk is something more dovish as that part of the narrative seems to be ebbing lately, so will be a real surprise.  If that is the case, then I suspect the dollar will suffer somewhat.

Good luck

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Much Havoc

Posted on by

Colombia tried to prevent
Deportees, who homeward were sent
But Trump’s strong response
Meant that in a nonce
Gustavo, his knee quickly bent
 
Meanwhile, all the talk of AI
This weekend has pundits awry
The Chinese DeepSeek
Could very well wreak
Much havoc in stocks priced sky-high

 

If there was any doubt that things were going to be different under a Trump administration than virtually any previous administration, even his first term, they were dispelled this weekend.  By now you will all have heard the story of the Colombian president, Gustavo Petro (he of the 26% local approval rating) and his refusal to allow two US C-17 military transports filled with Colombian deportees, land in Bogota.  Apparently, when Trump was informed while playing golf, after birdieing the 3rd hole, he tweeted that the US would immediately impose 25% tariffs on everything Colombia exports to the US, rising to 50% in one week if this policy was not changed.  By the time he finished the 6th hole, President Petro reversed his policy and even offered the Colombian presidential plane to come and pick up the deportees.

While the golf portion of the story is amusing, the lesson to the rest of the world is that President Trump is very serious about his electoral promises, and he will utilize the entire might of the US government to achieve his goals.  For smaller nations with little power and leverage, it means that toeing the line is the only solution.  For larger nations, it certainly is a wakeup call to the idea that the US attitude toward international relations has dramatically changed.  As Machiavelli explained, it is better to be feared than loved, and it seems abundantly clear that President Trump understands that.

Perhaps the biggest takeaway from this situation, though, is that the US government is no longer the slow-moving behemoth to which it had evolved over the past decades.  The rest of the world is going to find itself needing to respond very quickly to things that in the past were sent to committees for study and review but now are decided instantly.  If you want to understand why I believe volatility is set to increase across all asset classes, this is the crux of the issue.

Turning to the tech world, the buzz is all about DeepSeek, which is a Chinese AI model that allegedly outperforms OpenAI’s top model, or performs just as well, although it costs a fraction of what OpenAI and others (Microsoft, Google, etc.) spent to train the model and it uses far less advanced chips which are also much less expensive and less power hungry.  Because this is all a new story, it remains unclear if DeepSeek will be an effective replacement for the others, or if it excels in only one or two areas and still lags elsewhere.  

But the market impact has been instantaneous and dramatic.  At this hour (6:00am), the NASDAQ (-4.5%) is leading US equity markets lower with the S&P (-2.4%) along for the ride.  Nvidia (-10.6% in premarket trading) is leading the way, but I suspect that this news will be negative for the entire US tech sector.  After all, it was certainly priced at premium levels.  

Source: tradingeconomics.com

In the short term, I expect we are going to hear a lot more analysis of why this is a game changing event and how the future that was so clear just last week is now cloudy.  However, while this will almost certainly take the shine off the megacap tech companies for a while, I think it would be a mistake to dismiss their futures because of this.  Two things in their favor are they still have virtually infinite resources, and they have dramatically large installed networks which means that changing things will be very difficult.  While their equity prices can decline a lot, it doesn’t mean their businesses are going to collapse.

PS, spare a thought for the impact on the energy sector here as well.  One of the narratives that has been fed lately is that all this AI will require gobs of power that will need a lot more power production.  It was a key feature of the Uranium story as nuclear is seen as one of the few sources capable of delivering the reliable power necessary.  I suspect that this part of the narrative will need to adjust as well if the AI story has actually changed.  But keep in mind that with efficiency comes more demand, so perhaps this is just a temporary downdraft.  Again, volatility is the name of the game.

Ok, let’s see how these stories have impacted the rest of the world.  With all the news over the weekend, you may not recall that US equity markets edged lower on Friday.  Well, Asian markets were mixed overnight with the Nikkei (-0.9%) following the US, although also reacting to the fact that the yen (+1.3%) rallied sharply as well.  Meanwhile, Hong Kong (+0.7%) managed to gain while mainland Chinese shares (-0.4%) certainly showed no benefit from the changing attitudes in tech.  Elsewhere in the region, Korea (+0.9%) and Taiwan (+1.0%) rallied while India (-1.1%) and Indonesia (-0.9%) fell and the rest of the region batted back and forth. In Europe, red is the dominant color, likely on the generally weak US performance although there are no European tech companies of note (perhaps ASML).  But the DAX (-1.2%) is leading the way down followed by the CAC (-0.9%) and the bulk of the rest of the continent and the UK.  Let’s just say that equities are not in favor this morning.

However, what we are seeing is a major bond market rally as Treasury yields (-12bps) tumble as risk is very definitely off.  European sovereign yields are also lower, by between -5bps and -7bps, and JGB yields (-2bps) also slipped, although relative to the rest of the world, they held up pretty well.  Interestingly, with all the talk about DeepSeek and the impact on the tech community, there has been virtually no discussion about the myriad central bank meetings this week, including, of course, the Fed on Wednesday where the market still sees no chance of a rate cut.

Commodity markets are relatively calm this morning as oil (-0.6%) is a touch lower although there has been no news of note.  The background story is that President Trump and Saudi Arabia’s Mohammed bin Salman are talking about increasing production to drive oil prices lower, but that remains more rumor than anything else.  As the polar vortex has passed, and forecasts are for warmer weather, NatGas (-6.2%) is sliding.  In the metals markets, very little movement is ongoing as traders try to determine what all the new news means.

Finally, the dollar is under some pressure this morning despite the risk off attitude that prevails.  I suppose it is because one of the recent drivers of the dollar’s strength has been the insatiable demand for the megacap tech stocks.  It seems that for now, that demand has been satiated.  So, the yen is behaving in its traditional safe haven role, as is the CHF (+0.85%) but the euro (+0.15%) and pound (+0.15%) are both a touch higher.  That said, we are definitely seeing emerging market currencies under pressure as they have nothing to do with tech and everything to do with the very obvious change in attitude regarding how the US is going to deal with smaller nations that don’t accede to US demands, especially regarding immigration.  So, MXN (-1.0%), COP (-1.1%), ZAR (-1.4%) and BRL (-0.6%) are all under significant pressure.  CE4 currencies, though, are not in the line of fire, so are little changed this morning.  

On the data front, remarkably, it almost seems an afterthought given what we just saw this weekend, but along with the Fed, BOC and ECB, we get PCE on Friday.

TodayNew Home Sales670K
TuesdayConsumer Confidence106.0
WednesdayBank of Canada Rate Decision3.0% (current 3.25%)
 FOMC Rate Decision4..5% (current 4.5%)
ThursdayECB Rate Decision2.75% (current 3.0%)
 Initial Claims220K
 Continuing Claims1885K
 Q4 GDP2.8%
FridayPersonal Income0.4%
 Personal Spending0.5%
 PCE0.3% (2.6% Y/Y)
 Core PCE0.2% (2.8% Y/Y)
 Chicago PMI40.0

Source: tradingeconomics.com

At this point, the central bank story is background noise, not the major theme, but by Wednesday I expect that all eyes will be on Chairman Powell as he describes the Fed’s thoughts at the press conference.  Of course, that assumes that there are no other political earthquakes, which may not be a very good assumption these days.  I think we are in a seismic zone for now.  

As to the dollar, if DeepSeek really is an Nvidia killer, then it is not hard to derive a scenario that says, US equity markets are going to decline, along with growth expectations.  The Fed will cut more aggressively, and the dollar will start to really fall as well.  I’m not forecasting that, just highlighting a possible, if not likely, scenario in the event the world believes the AI story is not going to be as expensive and profitable for the Mag7 as they thought last week.  Once again, the key is to hedge your risks, because as you learned this weekend, things change, and they can change quickly!

Good luck

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