Tag Archives: #inflation

Not Yet Sealed the Deal

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Said Powell, the progress is real
And though there are many with zeal
To quickly cut rates
Our dual mandates
Explain we’ve not yet sealed the deal
 
Meanwhile, as the holiday nears
Investors, ‘bout some stuff, have fears
The UK will vote
And Labour will gloat
Then Payroll, on Friday appears
 
At this stage, the Payroll report
Is forecast to, last month, fall short
But if the U Rate
Once more does inflate
The doves, for rate cuts, will exhort

The Fed whisperer himself, the WSJ’s Nick Timiraos, did an excellent job covering the Chairman’s speech in Sintra, Portugal at a big ECB confab yesterday, so let me give it to you straight from him.  [emphasis added]

“We’ve made a lot of progress,” Powell said Tuesday on a panel with other central bankers at a conference in Portugal. After serious shortages two years ago that sent wages up sharply, the labor market has “seen a pretty substantial move toward better balance,” he said.

The Fed leader’s remarks underscored a sense of cautious optimism that had faded after disappointing inflation readings in April. He alternately said the economy had made “significant progress,” “real progress” and “quite a bit of progress” toward cooler inflation with stable growth.

Apparently, progress toward their stated goals has been substantial.  And while that is fantastic, he also mentioned, later in his speech, that they were now also looking far more carefully at the labor market, which is starting to slow down.  “You can see the labor market is cooling off, appropriately so, and we’re watching it very carefully.”  You may recall that SF Fed president Daly also focused on the labor market late last week and I am confident that it is on every FOMC members’ radar. 

Of course, that’s why Friday’s Payrolls report is going to be so important.  Arguably, while the NFP data gets all the press, the Unemployment Rate is really going to matter this time as it ticked up to 4.0% last month.  A rise from here will start to call into question just how strong the labor situation remains.  For instance, while yesterday’s JOLTS data showed a modest rise to just over 8M job openings, that is after the previous month’s data was revised down substantially, by nearly 240K jobs.  One of the things about the Unemployment Rate is that once it starts to move in one direction or the other, it tends to really build momentum for a while.  As you can see from the long-term chart below, once it starts to rise, it tends to go a lot higher. 

Source: tradingeconomics.com

I have maintained that the payrolls have been a key all along as it is quite easy for the Fed to parry complaints from Congress about ‘too high’ interest rates if the job market is tight.  But if it starts to loosen too quickly, Congress will be howling every day and night and make the Fed’s life quite miserable.  As such, my eye is on the Unemployment Rate rather than NFP come Friday.

Now, this is not the only story around, but from a market perspective, I believe it is the most important by far.  However, let’s touch on some others before highlighting the ongoing risk rally.  While most of the oxygen in US newsrooms is consumed by the debate on whether President Biden is fit to, and will, be the Democratic nominee, there are several other key elections coming this week.  

Tomorrow, the UK heads to the polls (was the July 4th date chosen to commemorate the last big English loss?) where the current Tory government, led by PM Rishi Sunak, is forecast to be decimated by the voters.  Apparently, the good folks of the UK are fed up with the same inflation and immigration issues that are apparent elsewhere in the Western world and are looking for a change.  Interestingly, a look at UK markets doesn’t really indicate that investors are greatly concerned over the change as Gilt yields, the FTSE 100 and the British pound have all been range trading for the past month.  Certainly, there is no indication a Labour government is going to be fiscally responsible, but they have promised to raise taxes to try to fund their spending.  In the end, I don’t see the change in government having an immediate impact on financial markets in the UK.  Rather, I expect that the US story on rates and economic activity is still going to be the main driver of things.

Come Sunday, the French head back to the polls for the second round of their parliamentary election and virtually every story you can read about it describes the lengths to which the coalition of left-wing parties and the current Macronist parties are going to try to prevent Marine Le Pen’s RN party from gaining a working majority.  I find it instructive that rather than considering why so many people were drawn to the RN message of restricting immigration and enhancing public safety, the other parties simply demonize the RN as a reincarnation of the Nazis.  (sounds familiar, no?).  The current market narrative seems to be that the RN will not be able to capture an absolute majority by themselves with the result that a caretaker government will be appointed with limited powers.  This has been seen as a great leap forward from the fear of an RN led government, and so we have seen French equity markets rebound from their worst levels last week, while French OAT yields have compressed vs. their German counterparts by about 15bps from the widest levels seen just before last Sunday’s first round votes.

In a related note, this morning I have seen several articles describing the recent rise in US yields as a response to the presidential debate last week, where suddenly there is concern that Mr Trump may win and spend trillions of dollars, rather than a Biden win where the government would spend trillions of dollars.  Frankly, there is no indication that either party is going to rein in spending, it is far more a question of their spending priorities.  But that is the story that is all over the press this morning.

Ok, a quick look at the overnight session shows that yesterday’s US equity rally was largely followed by shares in Asia (Nikkei +1.25%, Hang Seng +1.2%) although Chinese shares remain lackluster.  In Europe, as well, shares are higher across the board with the CAC (+1.55%) in Paris leading the way on this renewed narrative of a caretaker government.  I suppose if the RN does win a majority that come Monday, French shares, and most of Europe as well, will see sharp declines.  As to US futures, at this hour (7:30), they are edging very slightly higher, just 0.1%, ahead of this morning’s data dump.

In the bond market, Treasury yields are unchanged this morning, but Europe has seen virtually all sovereigns rally slightly vs. Bunds as the French narrative seems to have longer tails than one might imagine.  So, spreads are narrowing a bit.  The one consistency in bond markets, though, has been Japan which saw yields edge higher by another basis point overnight and are now 18bps higher in the past two weeks.  Remarkably, despite the rise in Japanese yields, the yen continues to get punished daily.

In the commodity markets, oil is little changed on the day, but has rallied more than 2% in the past week on rumors of a significant inventory drawdown to be reported later this morning, as well as the pending shut in of production in the Gulf of Mexico.  However, metals markets are rallying this morning with both precious (Ag +0.6%, Ag +1.8%) and base (Cu +1.6%, Al +0.7%) finding support amid the equity/risk rally and the dollar’s softer tone today.

Speaking of the dollar, other than the yen (-0.25%) which is now pushing to 162.00, the rest of the G10 bloc is modestly firmer, between 0.1% and 0.25%.  Meanwhile, in the EMG bloc, ZAR (+0.65%) is again the biggest mover, rallying on metals strength along with broad dollar weakness.  One must be impressed with the ongoing volatility in the rand, which seems to be the leading mover in one direction or the other every day.  However, away from that, while most EMG currencies are a bit firmer, the movement has been much less dramatic.

On the data front, it is a busy day as tomorrow’s holiday has forced much info onto today’s calendar.  As well, since there will be no poetry on Friday morning, I will include the current estimates of the payroll data as well

TodayADP Employment160K
 Trade Balance-$76.2B
 Initial Claims235K
 Continuing Claims1840K
 ISM Services52.5
 Factory Orders0.2%
 -ex Transport0.3%
 FOMC Minutes 
FridayNonfarm Payrolls190K
 Private Payrolls160K
 Manufacturing Payrolls5K
 Unemployment Rate4.0%
 Average Hourly Earnings0.3% (3.9% Y/Y)
 Average Weekly Hours34.3
 Participation Rate62.7%
Source: tradingeconomics.com

In addition to all this, we hear from NY Fed president Williams this morning, but given that Powell continued to highlight the lack of confidence that inflation was quickly going to reach their target, I doubt Williams will say anything different.  My concern is that we are going to see the Unemployment Rate rise to 4.1% or 4.2% and that will change the narrative greatly.  Suddenly, there will be a lot more pressure to allow inflation to stay at current levels or even go higher to address the employment side of the mandate.  As I have written in the past, any rate cuts before inflation is well and truly vanquished will likely result in a much weaker dollar and much higher commodity prices.  Be on the watch for Friday’s data to be the first step in that direction.

Good luck and have a good holiday weekend

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To Oblivion

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The yen continues
To grind ever so slowly
To oblivion

 

Well, for all those who were either concerned or anxiously awaiting USDJPY’s move to and above 160, we got there early this morning, and the world has not ended.  Not only that, but there is no sign of the BOJ/MOF, nor do I believe will there be for a while yet.  As I explained on Monday, history has shown, and the MOF has been explicit, that they are far more concerned with the pace of any movement in the currency, rather than the specific level at which it trades.  So this much more gradual decline in the yen, while potentially somewhat uncomfortable given its possible impact on inflation going forward, is just not alarming.  You can expect to hear Kanda-san or Suzuki-san reply when asked about the currency that they are watching it closely and prefer a stable currency, but I believe they are fairly relaxed about the situation this morning.

A look at the chart below from tradingeconomics.com shows the trend has been steady all year (which given the interest rate differential between the two currencies makes perfect sense) and that only when things accelerated back at the end of April did it generate enough concern for the MOF to act.  If we see another sharp movement like that, you can look for another round of intervention.  But, at the current pace, likely all we will get is some commentary about stable movement and vigilance.

Source: tradingeconomics.com

While many worldwide want to think
Inflation is starting to shrink
The data released
Shows it has increased
Down Under with Quebec in sync

With all eyes on Friday’s PCE data as a harbinger of the next Fed activity, it is worthwhile, I think, to mention what we have just seen from two other G10 nations regarding their inflation situation.  Starting north of the border, you may recall that earlier this month the Bank of Canada cut their base rate by 25bps in anticipation of achieving their 2% target given the prior direction of travel of their CPI statistics.  Oops!  Yesterday revealed that both the headline and core readings rose a much higher than forecast 0.6% in May, bringing the annual readings to 2.9% and 1.8% respectively.  As well, they focus on the Trimmed-Mean annual number, which also surprisingly rose to 2.9%.  now, one month does not a trend make, but Governor Macklem may have some ‘splainin’ to do the next time he speaks.  It is possible that inflation has not turned the corner after all.

Meanwhile, Down Under, the RBA must be feeling a bit better as they have maintained a more hawkish stance overall, arguably the most hawkish of any G10 member, and last night’s CPI reading of 4.0%, a 0.4% rise from the April data and 0.2% higher than forecast, is a reminder that inflation can be difficult to conquer for all central banks.  Since December, the readings Down Under had been in the low 3’s and many pundits were anticipating that the next leg was lower there as well.  Oops again!

With this in mind, it can be no surprise that the two Fed speakers yesterday, Bowman and Cook were both leaning toward the hawkish end of the spectrum.  In fact, Bowman even raised the possibility of future rate hikes as follows [emphasis added], “Reducing our policy rate too soon or too quickly could result in a rebound in inflation, requiring further future policy rate increases to return inflation to 2% over the longer run.”  At the same time (well actually, 2 hours earlier) Governor Cook did explain she sees rate cuts coming, just not the timing.  To wit, “With significant progress on inflation and the labor market cooling gradually, at some point it will be appropriate to reduce the level of policy restriction to maintain a healthy balance in the economy.  The timing of any such adjustment will depend on how economic data evolve and what they imply for the economic outlook and balance of risks.” 

It strikes me that no matter how you parse these comments, right now, there is no indication that pretty much anybody on the FOMC is considering rate cuts soon.  Futures markets have not really changed their pricing lately with a 10% probability of a July move and a 64% probability of a September cut.  However, one interesting tidbit is that in the SOFR futures options market, there has been a very substantial position building in March 2025 97.75 SOFR calls.  For these to pay off, Fed funds would need to fall about 300bps between now and March, far more than is discussed or priced right now.  While this could certainly be a position hedge of some sort, it does have many tongues wagging.

Ok, a review of the overnight session shows that we are still amid the summer doldrums overall, with some movement in markets, but nothing very dramatic and no real trends developing.  In Asia, the Nikkei (+1.25%) rallied on the back of the weak yen and is back approaching the 40K level, although a look at the chart shows simply choppy price action with no direction.  Hong Kong was flat, Shanghai (+0.65%) rose and Australia (-0.7%) fell on the back of that inflation data and the realization that the RBA is not cutting rates anytime soon.  In Europe, the movement has been weaker, rather than stronger, with French (-0.55%) and Spanish (-0.4%) shares both softer although German and UK shares are essentially unchanged today.  Finally, US futures are mixed with small gains for the NASDAQ and S&P while DJIA futures are following through on yesterday’s index declines.

In the bond markets, higher yields are the order of the day with Treasuries and virtually all of Europe higher by 3bps.  Overnight, JGBs saw a similar rise in yields which has now taken the 10yr yield there back above that 1.00% pivot.  The outlier here is Australia, which given the CPI data there, not surprisingly saw yields jump more, in this case by 11bps.

In the commodity markets, oil (+0.6%) is rebounding from yesterday’s modest declines which came about after API inventory data showed a modest build instead of the expected decline.  Gold (-0.4%) is under pressure along with most metals on the back of the dollar’s strength today.  In fact, my sense is the dollar is the driver right now.

So, speaking of the greenback, the only G10 currency to make a gain this morning is AUD (+0.15%) based on the higher yields Down Under.  Otherwise, the rest of the space is weaker between -0.2% and -0.5% with SEK the laggard.  In the EMG space, there is only one currency managing to hold its own, ZAR (+0.5%), which looks more like a trading bounce than a fundamental shift as there has been no data and no news yet on the political front regarding President Ramaphosa’s cabinet appointments.  Otherwise, the noteworthy move is that USDCNY has breached 7.30 for the first time since November as the pressure of higher US rates and an overall stronger dollar are too much to prevent continued weakness in the renminbi.

The only data this morning is New Home Sales (exp 640K) and the EIA oil inventories, which while important for the price of oil generally don’t have a macro impact otherwise.  As well, there are no Fed speakers on the calendar, but I cannot believe that at least one of them will want to hit the airways somehow.

So, the dollar has legs this morning and unless we get pushback that inflation is falling more clearly, I suspect that yields and the dollar will remain well bid.  It doesn’t feel like there is something that can change opinions due today.  Tomorrow and Friday, though, have that opportunity, so we shall see.

Good luck

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Thoroughly Schooled

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Has CPI actually cooled?
Or did April have us all fooled?
Both Tiff and Lagarde
Have played their first card
Has Jay now been thoroughly schooled?
 
First, if CPI comes in hot
The Chairman will certainly not
Decide to cut rates
And leave the debates
Til things show the damage he’s wrought
 
But if the inflation report
Is nothing at all of that sort
Then many have said
This summer, the Fed
‘Round rate cuts will gather support

 

A quick look at yesterday’s 10-year Treasury auction shows it was far better than the 3-year on Monday with a strong bid/cover ratio of 2.67, its highest since February 2022, and a result where the auction cleared 2bps lower than the pricing ahead of the announcement, a sort of negative tail.  Indirect bidders represented nearly 75% of the bids, so there was real demand for this paper.  Certainly, Janet and Jay are feeling better, and yields fell 6bps on the day.  

As I explained yesterday, the auctions are just one tiny signal in a large body of information, and just like almost everything else, it seems there is no consistency there either.  However, one auction does not a trend make.  One last thing, the strength of the auction ahead of today’s CPI report and FOMC meeting seems somewhat odd given the potential risks attached to both those events.  Generally, investors would prefer to reduce exposure ahead of a big event, not increase it.  This has awakened some conspiracy theorists as to who actually bought the paper.  There is no evidence that there was any behind the scenes Fed activity, but many are trying to figure out the incentive to aggressively bid for bonds ahead of key data.  We need to stay vigilant.  

Ok, on to the CPI this morning.  The current consensus forecasts are for the headline (0.1% M/M and 3.4% Y/Y) and the core (0.3% M/m and 3.5% Y/Y).  During the month of May, wholesale gasoline prices fell nearly 6% which is clearly weighing on the headline monthly outcome.  Of course, that is not a seasonally adjusted number, that is the raw result.  Last month, despite gasoline prices rising a similar amount, in the CPI data, the seasonally adjusted number showed a decline, and that is what is in the report.  That is just one of the many unusual features of the way CPI is calculated, and why it must be carefully considered.  

However, beyond gasoline prices, the indications of rising prices continue to come from things like the ISM Prices paid index for both Manufacturing and Services, as well as the robust wage growth from the NFP report last week.  And certainly, I am hard-pressed to have seen prices do anything but rise in the past month and year based on my personal consumption basket.  But I do not have an econometric model that I use to estimate these things like my good friend the @inflation_guy, who you all should be following on X(Twitter) or at his inflationguy blog.  However, based on the other pricing data we have seen, I expect that the risks to the consensus are on the high side, not the low side.  We shall find out at 8:30.

In this case, I think it is clear that a hot number will result in a sharp decline in bond prices (jump in yields), a rise in the dollar and, at least initially, a decline in equity markets.  Of course, the latter clearly have a life of their own.  A lower-than-expected print should see the opposite, with stocks ripping higher.

And lastly, we turn to this afternoon’s FOMC meeting.  At this point, the only thing that anyone is discussing is the dot plot.  Below is the March edition where the median indicated 3 rate cuts in 2024, but it was very close, a 10-9 outcome with 9 members seeing 2 cuts or less.

Source: federalreserve.gov

As I recall, I was far more interested in the idea that the Longer run rate, which is often defined as R* or the neutral rate, started to creep higher than its recent estimates of 2.5%.  Since the March meeting, there has been an uptick in discussion as to what the longer run rate should be, with every estimate rising some amount.  

As to the immediate situation, given there is a vanishingly small chance they adjust rates today, there are only four meetings left in 2024 so it would seem likely that the maximum number of cuts the updated version of the dot plot will indicate is two.  Personally, I think it will come in at one unless this morning’s CPI is much lower than expectations, although given the ECB managed to cut rates while raising their inflation forecasts, anything is possible in the convoluted world of central banking.  Funnily, the strength of yesterday’s 10-year auction may give them enough confidence that their current policy is not a problem resulting in an estimate of fewer cuts rather than more.

However, the real interest will be Powell’s press conference.  Based on everything we heard from Powell and all his acolytes prior to the quiet period, there certainly seemed to be no rush to cut rates as they still lacked confidence that inflation was going to head back to target.  And, of course, the biggest piece of data we have seen in the interim, last Friday’s NFP number, was much hotter than expected as was the wage data, so it doesn’t seem that he would change that tune.  Thus, much relies on this morning’s CPI and how that may change any opinions on the committee.  While I believe that his underlying desire is to cut rates, there does not yet seem to be an opening to do so.  In the end, my take is that the risk to the market is he is more hawkish than dovish with the corresponding risk-off results.  That’s what makes markets.

Ok, I’ve rambled on a lot already so suffice to say that the overnight price action was generally pretty benign as everyone around the world has been awaiting today’s CPI and FOMC.  Yesterday’s mixed US session was followed by a mixed Asian session with some gainers and some laggards although European bourses are feeling chipper this morning, with all higher by about 0.5%.  As to US futures, they are ever so slightly firmer at this hour (7:00), just 0.1%.

Bond yields around the world have followed Treasuries lower, with the US 10-yr falling one more basis point while all of Europe is down 2bps, except for Italy (-5bps) where the spread to bunds is narrowing on hopes of broader interest rate declines.  Even JGB yields (-4bps) softened last night.  As I have repeatedly explained, as goes the Treasury market, so goes the rest of the global bond market.

Oil prices (+1.1%) are climbing again after inventory data yesterday showed larger draws than expected while metals prices are little changed this morning after another weak session yesterday.

Finally, the dollar is on its back foot, down about -0.15% vs. most of its G10 counterparts save the yen (-0.2%) which continues to drift back toward that 160 level which catalyzed the BOJ’s intervention.  I think the dollar’s movement is the easiest to forecast ahead of the CPI and FOMC as hot CPI will see the dollar rally, as will a hawkish Fed, with the opposite also true in the event that things are cool and/or dovish.

And that’s really all today.  So, buckle up for the 8:30 data and then after that flurry, you can relax until 2:00pm.

Good luck

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None Be Unique

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When looking ahead to this week
The noteworthy thing is Fedspeak
At least fifteen times
They’ll give us their dimes’
Worth of knowledge, though none be unique
 
For instance, we already know
Their confidence is rather low
So, absent new data
Do they have schemata
Designed to get ‘flation to slow?

 

Arguably, the biggest news this morning is the death of the Iranian President and Foreign Minister in a helicopter crash overnight as it opens a range of possibilities regarding the future stance of Iran in the Middle East.  Will it remain the strict theocracy that it has been?  Or will a new leadership recognize the people appear to be growing tired of that stance and want something different.  While it would seem unlikely that there will be a major change, at least from this view thousands of miles away, if one were to come about, it would have a major impact on the Middle East and the ongoing conflict in Gaza.  After all, if Iran stopped funding terrorist groups, that would de-escalate things dramatically and potentially see a significant decline in the price of oil.  At this time, however, there is no information as to who will step into the role and what policies will be followed, so it is a wait-and-see period.  As it happens, oil prices (-0.35%) have edged lower this morning, but this is hardly a sign of anything new.  This will be quite critical to watch going forward.

However, beyond that, there has been vanishingly little new information about which to speak regarding the macroeconomic situation around the world.  The Chinese left their policy rates unchanged, as universally expected, and there has literally not been any other data from any major nation since Friday.  In fact, looking ahead at the calendar for the week, arguably the most significant piece of data to be released is Canadian CPI, or perhaps UK CPI and then on Friday we see the Flash PMI reports. 

Which brings us back to the Fedspeak.  It is staggering to think that the FOMC believes they need to be so visible at this time, especially after Chairman Powell explained that rate hikes were off the table and that while it may take a little longer than they had initially expected, they were still certain that inflation was going to head back to their 2% target.

Speaking of inflation, over the weekend I was reading some analysis (sad, I know) that highlighted if the US used the European HICP calculation the core reading would already be below their target with April’s data coming in at 1.9%.  To me this is a similar stance to what we heard at the end of 2023 when numerous pundits were explaining that the 3-month trend or the 6-month trend was already at 2.0% so why wait to cut?  Of course, the sticky inflation camp (this poet included) was quick to hoist them on their own petard as the recent 3-month and 6-month trends are pointing to 4+% CPI readings going forward.  

In this particular instance the question I would ask is, other than the fact that the reading is lower, why would anyone think that the European HICP inflation reading is a more accurate representation than the BLS representation?  The difference lies in the fact that HICP doesn’t incorporate housing price changes, which given they remain stubbornly high, have been supporting higher CPI readings.  But don’t people pay for their housing?  Certainly, it would be easy to create a lower CPI if you simply remove all the items that are going higher in price.  Unfortunately, that process doesn’t really tell you anything about reality.

Below is a very interesting chart I found on X (nee Twitter) created by Professor Alberto Cavallo of Harvard and Oleksiy Kryvtsov, a Bank of Canada economist, which may be a better description of inflation as felt by the average person.

The fact that prices are rising fastest for the least expensive goods indicates that inflation is a major problem for Joe Sixpack, and no matter how pundits seek to adjust the measurement, so the numbers look better, reality is a harsh mistress.  (If you want to know why President Biden’s numbers are so bad, you needn’t look further than this chart.)  

Alas, there is no escaping the plethora of blather that will be coming from the Fed this week, although I sincerely doubt any of it will change anyone’s opinions about anything.  Ok, it was another generally quiet session overnight with the exception being the ongoing blast higher in metals markets.

Equity markets have performed well across the board, although the gains have not been too dramatic.  Japan (Nikkei +0.7%) was the best performer although the entire region was in the green to a lesser extent, about 0.35% or so.  In Europe, all the bourses are higher as well, but here the gains are even smaller, on the order of +0.25% across the board while US futures are essentially unchanged at this hour (6:30).

In the bond market, Treasury yields, which backed up 2bps on Friday are unchanged this morning while European sovereigns are higher by roughly 1bp across the board.  ECB speakers have conceded that a rate cut is coming in June, but many are pushing back hard against the idea that a July cut is a sure thing, preferring to wait until September.  However, the really interesting thing is in Japan, where JGB yields have traded up to 0.98%, a new high yield for this move and a level not seen since March 2012.  At this point, it would seem that 1.00% is a foregone conclusion so it will be interesting to see how the BOJ responds when that ‘magic’ number is finally traded.

But, as I mentioned above, it is a metals day with gold (+0.9%), silver (+1.1%) and copper (+0.9%) all continuing last week’s strong gains with gold making yet further new highs, copper pushing its historic highs and silver breaking above a key technical resistance level at $30/oz last week and now extending those gains.  While there have been many explanations for this price movement, I think you need to consider precious and industrial metals separately.  For precious, there continues to be a growing concern in the ongoing debasement of the fiat currency universe and both individuals and central banks are seeking to hold alternative assets.  On the industrial side, though, especially copper and silver which are both critical to electronics, the ten-year hiatus in investment due to the ESG cult combined with the recent recognition that all the new-fangled tech wizardry like AI is going to require gobs of power and electrical capacity has simply skewed the supply/demand curve to much more demand than supply.

Finally, the dollar is little changed this morning, pretty much at the same level overall since Thursday.  Given the lack of movement in the rates space, this ought not be a surprise.  It also ought not be surprising that the best performing currencies of the past week have been CLP (+3.5%) as it has simply traveled alongside its major export, copper, and ZAR (+5.1%) as it rallies alongside the precious metals complex.  Meanwhile, there has been no movement in the interest rate narrative with, perhaps, the exception of Japan, but what we have learned there lately is that higher JGB yields lead to a weaker yen.  Go figure!

On the data front, as I said earlier, it is extremely light this week,

WednesdayExisting Home Sales4.22M
 FOMC Minutes 
ThursdayInitial Claims220K
 Continuing Claims1799K
 New Home Sales680K
FridayDurable Goods-0.7%
 -ex Transport0.1%
 Michigan Sentiment67.6
Source: tradingeconomics.com

It is not clear, given how much we have already heard from Fed speakers since the last FOMC meeting, that the Minutes will be very informative.  Perhaps the discussion about QT will change some minds, but I doubt it.  Otherwise, if stocks continue to rally, market players will be happy and not try to rock the boat.  Meanwhile, the dollar will need a new impetus to break out of this narrow range, but that may not come until next month’s NFP data.

Good luck

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Jejune

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Come Wednesday through Friday this week
It’s payrolls and Powell to speak
Let’s take time today
To hear people say
What’s driving the year-to-date streak
 
The first key is so many think
That Powell and friends need to blink
And cut rates quite soon
Else markets will swoon
And ‘flation will not rise, but sink
 
The other idea that’s around
Is AI and Bitcoin are bound
To fly to the moon
An idea, jejune,
For OG’s, though elsewhere profound

 

Once again, lackluster was an apt description of the market activity yesterday, although given the plethora of information that is on the horizon, we cannot be surprised by this result.  As such, I thought it might be worthwhile to review the themes that seem to be driving markets these days, as well as how expectations are built into pricing.

Clearly, the biggest story remains the Fed and its potential timeline for the mooted rate cuts necessary to achieve the much-vaunted soft landing.  As of this morning, the probability of a May cut remains near 24% with June the odds-on favorite for the first action.  While there has been some back and forth with respect to the actual probabilities, there has been no major change in that view for several weeks.  My question continues to be, why are so many people of the opinion that the Fed must cut rates?  

So far, at least based on both the GDP and payroll data, the economy is chugging along quite well with the current monetary policy settings while inflation remains well above the Fed’s target.  Arguably, a great deal of that is due to the fiscal impulse that has been ongoing, but there is no sign that is going to end anytime soon.  In fact, it strikes me that easing monetary policy amid a period of fiscal excess may juice the inflation data substantially.  Literally every Fed speaker has made this exact point, that things are going well, inflation seems to be trending lower, but there is more certainty needed before a cut would be appropriate.

Adjacent stories here are related to the election in the US, with many assuming the Fed will cut rates to help support the Biden administration (I think this is extremely unlikely).  The other key story has to do with the other G7 central banks, and their ability/willingness to change policy prior to the Fed.  Considering that Japan, Canada, the UK and Europe are all basically in recession, or right on the cusp, there is a far greater need to ease monetary policy in those places.  However, they have a serious concern that if they cut before the Fed, the dollar will rally sharply and negatively impact both economic activity and market activity, as well as undermine their currencies.  In the end, everybody is waiting for Godot Powell, and it is not clear he is going to come through.

The second key story is the remarkable performance of both Bitcoin and the tech sector.  There have been many stories comparing the current move in the NASDAQ to various times in the late 1990’s and the runup to the Tech bubble then.  We all know that eventually, despite the internet having an amazingly profound impact on all our lives, the tech sector corrected more than 80% from its early 2000 peak and it took 15 years to regain those levels.  I don’t think anybody is willing to say that the current tech leaders are bad companies with problems, but the price one pays for a company’s shares is THE key to long-term investment performance.  AI can be transformative in many ways and that doesn’t mean these shares will not decline and decline sharply.

Speaking of AI’s impact, my good friend the @inflation_guy, Mike Ashton, wrote a terrific piece about the potential impact on the economy overall, comparing it to the internet, the last significantly transformative technological revolution.  This is a must read!  Ultimately, while the impact of the internet was significant, it was not nearly as productivity enhancing as many had forecast at the initial stages of the mania.  Just keep that in mind with respect to AI as well.

As to Bitcoin, it is pushing to new all-time highs as flows into the spot ETF’s are quite substantial and driving the move.  However, it strikes me that the rationale for buying Bitcoin is very different than the rationale for buying NVIDIA.  Bitcoin believers are concerned over the integrity of the entire concept of money and its future.  They look at the dramatic increase in Treasury issuance and ask, is that debt really risk-free?  They are seeking to own alternative assets, outside the current monetary framework.  Meanwhile, buying the AI craze is as mainstream as you can get, counting on the equity values to rise substantially from here and protect your wealth, even if it is denominated in a currency that is subject to inflation and devaluation.  But for now, the two are linked at the proverbial hip.  

I would not look to short either process at this point, but having seen numerous bull markets in my time, the one thing I know is that trees don’t grow to the sky.  At some point, there will be a significant correction in both these asset classes, and we are sure to hear a great deal of screaming about how the Fed needs to come in and stop it.

In China, last night Premier Li
Revealed what their growth ought to be
Though clearly well-meant
To reach five percent
Is certainly no guarantee

 

One other key story overnight was Premier Li Qiang’s speech in which he declared the GDP growth target for China this year is “around 5%” with inflation to run at 3% and a budget deficit also at 3%.  While this all sounds great, there is reason for some skepticism.  Perhaps the biggest issue is that domestic demand for products is not growing and is unlikely to start doing so until the property crisis is behind them.  However, given President Xi’s unwillingness to face that music, the drawn-out process to address the situation will likely weigh on overall economic activity for a few more years yet.  

There is a potential knock-on effect of this, though, and something that I have not really considered in the past but need to investigate further.  We all know that there is a concerted effort by G10 nations to reshore and friendshore manufacturing capacity, and that has been a key driver of US economic activity.  Recall, that was the entire goal of the Inflation Reduction Act.  It has also been clear that there is currently a boom in factory construction in the US, something else supporting GDP data.  Now, if the US, and much of the G10, is adding to manufacturing capacity while China maintains its own manufacturing capacity, that is a LOT of capacity to build stuff.  It is not unreasonable to expect that the prices of manufactured goods will decline given what could well be significant excess supply.

In the US, regardless of who wins the presidential election, it is very easy to foresee another increase in import tariffs on Chinese goods (Trump has proposed a 60% tariff on all Chinese imports).  We have heard similar rumblings from Europe as well.  The point is that absent a substantial change in trade policy, goods inflation is likely to be well-contained.  Services inflation is a different issue, and given services represents a much larger proportion of the US economy, seems likely to keep price pressures pushing higher.  But rampant price rises are far less likely if we wind up with duplicate production sources for various goods.  Of course, tariffs will feed directly into inflation data, and the Fed cannot address that at all.

My point is that the economy is a highly interconnected and complex system and tracking all the potential outcomes is extremely difficult, if not impossible.  This is just one that I hadn’t considered in the past but may have some legs.  To be continued…

Ok, I have gone on too long so here’s the recap for overnight.  The Hang Seng sold off (-2.6%) but otherwise in Asia and Europe shares are little changed.  Yields are broadly lower (Treasuries -3bps, Europe -5bps on average) while oil prices have slipped a bit.  Gold (+0.5% and new all-time highs) is the commodity outlier.  Finally, the dollar remains little changed and is likely to stay that way until we see the next monetary policy adjustments.

ISM Services (exp 53.0) is the only data release today and only Michael Barr is speaking. I see no reason for things to move very far until tomorrow, when both ADP Employment is released, and Chairman Powell testifies.  Equity futures are pointing a bit lower this morning after a soft session yesterday.  That drift feels like it can continue as we await the rest of the week’s news.

Good luck

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Thought-Provoking

Posted on by

My sight is clearing
I now see the price target
Closer than you think

“With monetary easing continuing, I believe we have reached a point where attainment of the 2% price stability target is finally in sight, despite uncertainty over the Japanese economy.  It is necessary to consider shifting gears from extremely powerful monetary easing … and how we should respond nimbly and flexibly toward an exit.”  So said BOJ member Hajime Takata last night at a meeting with business leaders in western Japan.  These are the strongest words we have heard, I would argue, and the market did respond with the yen strengthening (+0.5%) and now right on the 150.00 level, while 2yr JGB yields rose another basis point, up to 0.18%, and its highest level since 2011.  I always find the BOJ wording to be odd as they try to be nimble and flexible in something that doesn’t appear to offer opportunities to behave in that manner.

Regardless, this has encouraged a more hawkish take on Japan with the probability of their first rate hike occurring in March rising to 26% from a previous level in single digits.  But despite these comments, we must remember this is from a single BOJ speaker.  Unless and until we hear this tone from multiple BOJ board members, I maintain that while an April move to 0.00% is possible, movement much beyond that seems very premature.  After all, last night saw IP in Japan fall -7.5% in January which takes the Y/Y number to -1.5%.  Recall, too, that Japan is in the midst of a technical recession.  It just doesn’t seem like tightening monetary policy is the prescription for what ails that nation.

However, the Japanese story is for the future as we have already seen the initial knee-jerk reaction.  And that means that all eyes are going to be on the US data at 8:30.

So, what if Core PCE’s smoking?
It seems that might be thought-provoking
If that is the case
We’d all best embrace
The idea the bulls will start choking

The flipside’s a cool PCE
Which winds up at zero point three
If that’s the result
The stock-buying cult
Will take every offer they see

As the market awaits this morning’s PCE data, a quick recap of yesterday seems in order.  I think you can argue that the data indicated economic activity remains at quite a high pace.  While the second look at Q4 GDP was revised down a tick, it is still at 3.2%.  The sub-indices showed that prices rose a bit more than expected and that Real Consumer spending rose a better than expected 3.0%.  The other data point was the Goods Trade Balance which showed a larger than expected deficit, a sign that imports are growing faster than exports.  This is typically a growth scenario, not a recessionary one, so nothing about the data hinted at a slowdown in things.

As well, we heard from three different Fed speakers and to a (wo)man they all explained that they remain data dependent and that the total economic situation was what they were following, not simply the inflation rate.  My point is that there is no indication that they are anywhere near ready to cut rates.

Turning to this morning’s release, expectations are as follows: Headline (0.3%, 2.4% Y/Y) and Core (0.4%, 2.8% Y/Y).  As well, we do see some other important data with Personal Income (exp 0.4%), Personal Spending (0.2%), Initial Claims (210K), Continuing Claims (1874K) and Chicago PMI (48.0).  But really, it is all about PCE.

My take is things are quite binary for a miss from expectations.  A hot print, 0.5% or more, will result in a sharp risk-off session as market participants will reduce the probability of future rate cuts.  This should see both stocks and bonds sell off, while the dollar rallies.  In contrast, a 0.3% or lower print for Core PCE will see the opposite outcome with a massive equity rally along with a huge bond rally, especially the front of the curve, and I suspect that futures markets will juice the odds of a May cut again (March is off the table no matter what.)

Of course, the last choice is a release right at the consensus view.  In that case, both sides of this argument will continue to argue their points, but my take is, based on yesterday’s price action, that equities may have a bit further to correct on the downside absent some other news that encourages the idea of stronger real growth, or an increased probability of a Fed cut.  One other thing to remember is we get four more Fed speeches today and this evening, so regardless of the outcome, there will be a lot of opportunity to reinforce their views.

Heading into the data release, a quick look at the overnight session shows us that the Asian market was quite mixed with Japan very little changed, a small decline in Hong Kong, but mainland Chinese shares rose sharply (CS! 300 +1.9%) as traders are looking for the government to announce a new fiscal stimulus package after they meet next week and roll out their growth targets for the coming year.  it strikes me there is ample opportunity for disappointment here given how unwilling Xi has been to do just that.  The European picture is equally mixed with some gainers (UK and Germany) and some laggards (France and Spain) although not a huge amount of movement in either direction.  There was a lot of Eurozone data released this morning with weak German Retail Sales, slowing growth in Scandinavia, and inflation throughout the continent coming in just a touch hotter than forecasts, although still trending lower.  And, after a lackluster day yesterday, US futures are softer by -0.2% at this hour (7:00).

In the bond market, yields are rising this morning with Treasuries (+4bps) back above 4.30% and all European sovereigns rising by at least that much.  In fact, UK Gilts (+7bps) are leading the way after some slightly better than expected housing data.  10-year JGB yields also edged up by 1bp after the Takata comments, but remain far below the 1.00% level that is still seen as a YCC cap.

Oil prices are a touch softer this morning, -0.4%, after a modest gain yesterday.  The big story remains the rumors of OPEC+ continuing to restrict their production.  In the metals markets, precious metals are under modest pressure this morning, but base metals are holding their own, with aluminum leading the way higher by 0.6%.

Finally, the dollar, away from the yen, has really done very little overall.  Looking at my screen, the only currency that has moved more than 0.2% in either direction is NZD (-0.25%) which seems to be continuing yesterday’s price action after the less hawkish RBNZ meeting outcome.  Otherwise, nada.

As we await the PCE data, and the Fedspeak later in the day, the one thing to remember is that if we see a soft number and the equity market cannot hold its early gains, that would be quite a negative signal for risk assets in the near term.  There are many who believe we are in a bubble market, especially the tech sector, and certainly there are many frothy valuations there.  It would not be hard to imagine a correction happening just because.  But if a market falls on ostensibly bullish news, that correction could have a little more oomph than most would like to see.  I’m not saying this is my expectation, just that it is something to keep in mind.  As to the dollar, that remains beholden to the monetary policy choices and so far, they haven’t changed.

Good luck
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Annoyed

Posted on by

Seems President Xi is annoyed
His stock market has been devoid
Of buyers, so he
Has banned, by decree
The strategies quant funds employed
 
But otherwise, markets are waiting
To see if inflation’s abating
The PCE print
Will give the next hint
If cuts, Jay will be advocating

 

Market activity remains on the quiet side of the spectrum as all eyes continue to focus on the Fed, and by extension all central banks.  As an indication, last night the RBNZ left their OCR rate on hold, as widely expected, but sounded less hawkish in their views, dramatically lowering the probability that they may need to hike rates again.  Prior to the meeting, there was a view hikes could be the case, but now, cuts are seen as the next step.  The upshot is the NZD fell -1.2% as all those bets were unwound.  One of the reasons this was so widely watched is there are some who believe that the RBNZ has actually led the cycle, not the Fed, so if hikes remained on the table there, then the Fed may follow suit.  However, at this stage, I would say all eyes are on tomorrow’s PCE print for the strongest clues of how things will evolve.

Before we discuss that, though, it is worth touching on China, where last night “unofficially” the Chinese government began explaining to hedge funds onshore that they could no longer run “Direct Market Access” (DMA) products for external clients.  This means preventing new inflows as well as winding down current portfolios.  In addition, the proprietary books using this strategy were told they could not use any leverage.  (DMA is the process by which non broker-dealers can trade directly with an exchange’s order book, bypassing the membership requirement, and in today’s world of algorithmic trading, cutting out a step in the transaction process, thus speeding things up.)  

Apparently, this was an important part of the volume of activity in China, but also had been identified as a key reason the shares in China have been declining so much lately.  Last night was no exception with the Hang Seng (-1.5%) and CSI 300 (-1.3%) both falling sharply and the small-cap CSI 1000 falling a more impressive -6.8%.  Once again, we need to ask why the CCP is so concerned about the most capitalist thing in China.  But clearly, they are.  I suppose that it has become a pride issue as how can Xi explain to the world how great China is if its stock market is collapsing and investment is flowing out of the country.  This is especially so given the opposite is happening in their greatest rival, the US. 

But back to PCE.  It appears that this PCE print has become pivotal to many macroeconomic views.  At least that is the case based on how much discussion surrounds it from both inflation hawks and doves.  As of now, and I don’t suppose it will change, the current consensus view of the M/M Core PCE print is 0.4% with a Y/Y of 2.8%.  As can be seen from the below chart from tradingeconomics.com, this will be the highest print in a year, and it would be easy to conclude that the trend here has turned upwards.

Of greater concern, though, is the idea that just like we saw the CPI data run hotter than expected earlier this month, what if this number prints at 0.5%?  Currently, the inflation doves are making the case that the trend is lower, and that if you look at the last 3 months or 6 months, the Fed has already achieved their target.  Their answer is the Fed should be cutting rates and soon.  For them, a 0.5% print would be much harder to explain and likely force a rethink of their thesis.

On the other side of the coin, the inflation hawks would feel right at home with that type of outcome and continue to point to the idea that the ‘last mile’ on the road back to 2.0% is extremely difficult and may not even be achievable without much tighter policy.  While housing is a much smaller part of the PCE data than the CPI data, remember, CPI saw strength throughout the services sector and that will be reflected.

One thing to consider here is the impact a hot number would have on the Treasury market.  Yields have already backed up from their euphoric lows at the beginning of the month by nearly 50bps.  Given the recent poor performance in Treasury auctions, where it seems buyers are demanding higher yields, if inflation is seen to be rising again, we could see much higher yields with the curve uninverting led by higher 10-year yields.  I’m not saying this is a given, just a risk on which few are focused.  In the end, tomorrow has the chance to be quite interesting and potentially change some longer-term views on the economy and the market’s direction.

But that is tomorrow.  Looking overnight, while Chinese stocks suffered, in Japan, equity markets were largely unchanged.  In Europe this morning, there is more weakness than strength with the FTSE 100 (-0.7%) and Spain’s IBEX (-0.7%) leading the way lower although other markets on the continent have seen far less movement.  As to US futures, at this hour (8:00), they are softer by about -0.3%.

In the bond market this morning, Treasury yields have fallen 2bps, while yield declines in Europe have generally been even smaller, mostly unchanged or just -1bp.  The biggest mover in this space was New Zealand, where their 10-year notes saw yields tumble 9bps after the aforementioned RBNZ meeting.

Oil prices (-0.3%) are giving back some of their gains yesterday, when the market rallied almost 2% on stories that OPEC+ was getting set to extend their production cuts into Q2.  It is very clear that they want to see Brent crude above $80/bbl these days.  In the metals markets, while precious metals are little changed, both copper and aluminum are softer by about -0.5% this morning.  I guess they are not feeling any positive economic vibes.

Finally, the dollar is much firmer this morning against pretty much all its counterparts.  While Kiwi is the laggard, AUD (-0.7%), NOK (-0.7%) and CAD (-0.4%) are all under pressure as well.  The same is true in the EMG bloc with EEMEA currencies really suffering (ZAR -0.5%, HUF -0.7%, CZK -0.4%) although there was weakness in APAC overnight as well (KRW -0.4%, PHP -0.6%).

On the data front, this morning brings the second look at Q4 GDP (exp unchanged at 3.3%), the Goods Trade Balance (-$88.46B) and then the EIA oil inventory data.  We also hear from Bostic, Collins and Williams from the Fed around lunchtime.  Yesterday’s data was generally not a good look for Powell and friends as Durable Goods tanked, even ex-transport, while Home Prices rose even more than expected to 6.1% and Consumer Confidence fell sharply to 106.7, well below the expected 115 reading.  

As we have been observing for a while now, the data continues to demonstrate limited consistency with respect to the economic direction.  Both bulls and bears can find data to support their theses, and I suspect this will continue.  With that in mind, to my eye, there are more things driving inflation higher rather than lower and that means that the Fed seems more likely to stand pat than anything else for quite a while.  Ultimately, I think we will see the ECB and BOE decide to ease policy sooner than the Fed and that will help the dollar.

Good luck

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What If?

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What if inflation’s not dead
And set to go higher instead?
Can Fed funds still fall?
Well, that’s a tough call
If not, look for trouble ahead

 

As we await Tuesday’s latest CPI data, I thought it might be a good time to review how things currently stand on a macro basis.  As I am just an FX guy, I am not nearly smart enough to see through the headlines and determine what is wrong with the narrative story of Goldilocks.  However, I can look at the actual numbers and perhaps we can draw some conclusions from that data.

Let’s start with CPI, as that is the next shoe to drop.  Looking at the last twelve months of monthly data, we see the following results on both an original and adjusted basis:

 CPI m/mannualizedCPI m/m (adj)annualized
Dec-230.33.60.22.4
Nov-230.23.00.22.4
Oct-230.12.40.12.0
Sep-230.43.00.42.7
Aug-230.53.60.53.36
Jul-230.23.40.23.2
Jun-230.2 0.2 
May-230.1 0.1 
Apr-230.4 0.4 
Mar-230.1 0.1 
Feb-230.4 0.4 
Jan-230.5 0.5 
Data tradingeconomics.com, calculations @fx_poet

Since the January 2024 data hasn’t been released, there would ordinarily be no revision yet.  However, as I wrote last week, the BLS does an annual revision which lowered the December 2023 result by a tick.  

As you can see that one tick had a big impact on the annualization trend for the past 6 months, and especially the past 3 months (highlighted), reducing it substantially.  Now, given the imperfections of the measuring process, 0.1% is probably not significant in the broad scheme of things.  But oh boy, for the narrative, it is everything.  Prior to that revision, it was pretty easy for those who believe inflation has bottomed to highlight that turn higher in the annualization rate.  This was especially true given how much the ‘inflation is dead’ crowd was relying on just that point.  But now that turn looks like a dead-cat bounce and is not nearly so impressive.  Tuesday’s outcome will be quite interesting as anything that is soft will almost certainly encourage the doves to be calling for a March cut more aggressively, and just as certainly, we will see risk assets rally sharply as the dollar declines.  A hot print, though, 0.3 or more, will have the opposite impact.

What if the ‘conomy’s state
Was built by the deficit’s weight?
And actual growth
Ain’t fast, but more sloth
Will Janet, more spending create?

 

When looking at GDP data and Federal government expenditures, it becomes pretty easy to determine why GDP continues to percolate along so well.  Given that GDP = Consumption + Investment + Government + Net eXports (Y = C + I + G + NX), a quick look at the G component shows just how much support the government has been adding to the economy despite what has been recorded as strong growth.  Or perhaps, more accurately, this is why growth has been so strong.  The below chart shows the trend of government expenditures relative to total GDP growth.  I removed the Covid years because they are extremely volatile and confusing. However, looking at the trend since the GFC in 2008/2009, there has been a step change higher in the amount of government activity measured in the economy. 

Source: data FRED St Louis Fed, calculations @fx_poet

Given the current budget deficit is running > 7% of GDP and is projected to remain at least this high going forward, it is quite clear that there is a lot of nonorganic effort to raise the GDP measures.  Look at the sharp upward turn at the right side of the chart.  It appears that the administration will do everything they can to continue to show that the economy is strong.  

Of course, this is where the rubber meets the road.  If the administration continues to pump more government spending into the economy, can inflation really decline any further?  Remember, government spending is almost entirely consumption based, with limited investment at this time.  Even the CHIPS Act only created incentives for private companies to invest, it is not government investment per se.  The point is, pumping up consumption demand without adding productive capacity is very likely to drive prices higher.  And if anything, given this administration’s war on energy markets, they are discouraging investment in critical infrastructure.  It is hard to see how this plays out for a Goldilocks outcome.  Far more likely, in my view, is that they continue to pump as hard as possible, and prices start moving higher again.  Timing is everything in life, and perhaps they can work it out so price hikes are delayed until after the election, but I am skeptical given the vast incompetence this administration has shown in virtually every sphere in which it operates.

What if employment’s a mess
And actually in some distress?
Is JOLTS data real?
And what is the deal
With households, it’s hard to assess

 

The last big macro area is, of course, the employment situation.  We all know that the NFP report was much stronger than expected for January, rising 353K, but also seeing upward revisions of the previous months for the first time in quite a while.  In fact, one of the bearish stories had been that the revisions mattered more than the headline data, and if revisions were for the worse, that was indicative of a slowing economy.  

Remember, too, that the US employment situation is measured in two ways, via the establishment survey which is a survey of companies’ (both large and small) actual hiring activity and leads to the NFP number, and the household survey, which is a telephone survey of ~60,000 households and asks the question if someone is employed and if not, whether they are looking for work.  The Unemployment Rate is calculated from the household survey, so both are clearly critical in assessing the situation on the ground.  

The funny thing is that the numbers come across pretty differently when you dig down.  While in the long-term, both data series have shown a strong correlation (96% since January 2000), the Household survey is far more volatile and in the past year has been telling a somewhat different story than the establishment survey.  Look at this chart below mapping each since the beginning of 2023:

Source: data FRED St Louis Fed, calculations @fx_poet

Doing the math shows that the establishment survey claims that 3.409 million jobs were created while the Household survey comes in at just over half that amount, 1.852 million jobs.  Now, in a nation of 330 million people, especially given the expansion of the gig economy and the dramatic changes in employment overall, maybe that is not such a big deal.  As well, simply looking at the two lines shows that the Household survey is far more volatile than the Establishment survey.  Does this mean we should ignore the household survey, given it seems to have more noise and less signal?  The problem with this is the household survey drives the Unemployment Rate, and nobody is willing to ignore that.  And these differences beg the question, is the employment situation as rosy as it seems?  With the Unemployment rate remaining so low for so long, it certainly appears that there is ample demand for workers.  Of course, that also implies that the cost of labor seems unlikely to decline very much and could well increase further and faster.  If that is the case, the impact will be seen in the inflation data as well.

Trying to sum things up here, looking at the three critical macro variables, inflation, growth and employment, there is a strong case to be made that the combination of ongoing government support and continued demand for labor into an aging workforce can lead to solid nominal GDP growth with inflation remaining far stickier than many currently anticipate.  If that is the situation, all the hopes and dreams of the interest rate doves may be delayed, if not destroyed, as it will be increasingly difficult for the Fed to ease policy into an inflationary environment.  Arguably, this is why they are seeking greater confidence that inflation is really dead.  

Now, maybe Goldilocks is real, and inflation will continue to decline on its own because…well just because.  But I find it hard to look at the data and conclude that lower inflation is our future, at least for any length of time.

Ok, this has gotten much longer than I intended but fortunately, absolutely nothing of note happened overnight in markets.  Literally.  There has been de minimis movement in stocks, bonds, commodities and currencies, and there is a distinct lack of data to be released today.  Tomorrow’s CPI is THE number of the week, so perhaps that will get the juices flowing again and drive some movement.  Until then, a quiet day is usually a good one on which to establish hedges.

Good luck

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Singing the Blues

Posted on by

Here’s what’s underlying most views
Inflation is yesterday’s news
But what if it’s not
And starts to turn hot?
Those bulls will be singing the blues
 
So, care must be taken, I think
As in the bulls’ armor, a chink
Is wages keep rising
While homes are surprising
Be careful, the Kool-Aid, you drink

 

Market activity has generally been benign as investors and traders await the next big news.  Arguably, that is next Tuesday’s US CPI data given the dearth of new information otherwise due to be released this week.  The one thing we have in spades this week is central bank speakers, with three from the Fed yesterday and four more today, including the first comments I have seen from the newest Governor, Adriana Kugler.  As well we have been regaled by ECB, BOE and BOC speakers and they will continue all week as well.

Thus far, the message has been pretty consistent with the general theme that inflation has fallen nicely and is expected to continue to do so.  However, in a great sign of some humility, they are unwilling to accept that because price levels have fallen for the past 3 months that their job is done.  Obviously, the recent NFP and ISM data have shown no indication that the economy is even teetering on the brink of a slowdown, let alone desperate for rate cuts for support.  And for this, I applaud them.

But in this case, the central bank community seems to be in a small minority of economic observers who are not all-in on the idea that rate cuts are necessary right now.  Because, damn, virtually every other analyst seems to be on that train.  

There is a very good analyst group that calls themselves Doomberg, which mostly write about energy policy and its impacts on everything else, but in this morning’s article, I want to highlight a more general comment they made which I think is really important:

“How can you tell the difference between an analyst and an advocate? It is all in the handling of data that runs counter to assertion. To an analyst, being wrong is disappointing, but it is primarily an opportunity to learn—an expected element in a feedback loop of continuous improvement. When knowledge is your only objective, there is no such thing as a bad fact, only one which you do not yet understand. Not so for the advocate. The advocate has tied their hopes (and often their livelihoods) to a specific outcome and feels compelled, whether consciously or not, to rationalize away or attack inconvenient realities. It is advocacy when every perturbation in the weather is tagged as evidence of climate change, each squiggle of unfavorable price action is declared market manipulation, and no act or utterance from a favored politician is disqualifying.”

First, I cannot recommend their writings highly enough as they are consistently thoughtful, well-researched and important.  But second, I think this point is exactly in tune with the Goldilocks welcoming committee as they will ignore every piece of data that runs counter to their narrative and double down by saying the Fed is overtightening because inflation is collapsing, and deflation is going to be the economic problem soon.

While I am often quite critical of the Fed and their comments, and still think they speak far too much, right now, I am very happy to see them maintain a reluctance to cut rates just because the market is pricing in those cuts.  Certainly, to my eye, looking at the totality of the data (as Chairman Powell likes to say) there is little indication that prices are collapsing.  In fact, the super-core data, which was all the rage last year, has turned higher.  I understand why Wall Street analysts are better described as Wall Street advocates, but for the independent analysts out there, and over the past several years those numbers have exploded higher, it is remarkable to me that more of them are not suspect on the idea that rates need to be cut and cut soon.  In fact, at this point, one month into the year, I continue to like my 2024 forecasts of perhaps one cut in the first half of the year, but a reversal as inflation reignites.

Yes, the futures market is now only pricing five cuts into 2024, but nothing has changed my view that the pricing is bimodal, either 0 or 10 cuts will be the outcome, with the former if the economy continues along its recent pace and the latter if the recession finally arrives.  Given that interest rates, led by Treasury yields, are the clear driver of global market movements, and given that inflation is going to play a critical role in their movement going forward, I have altered my view as to the most important piece of data.  Whereas I used to believe it was NFP, it is now entirely CPI/PCE.  As I wrote yesterday, if next week’s print is at 0.4% M/M, watch out for a significant repricing.

But now, let’s turn to today.  President Xi continues to have problems with his stock market and is seemingly getting a bit more desperate aggressive in his efforts to prevent a complete implosion.  Last night, the head of the CSRC (China’s SEC analog) was replaced as blame needs to be placed on others for Xi’s policy errors.  It ought not be surprising that Chinese shares, after a weak start, rebounded on the news and closed higher by about 1%.  However, the Hang Seng could not manage any gains and the Nikkei edged lower as well.  All in all, it was not a great session overnight.  In Europe this morning, the markets are lower by between -0.25% and -0.5% as once again we saw weak German data (IP -1.6%) continuing to point to a recession on the continent.  Finally, US futures are basically flat at this hour (7:30).

In the bond market, yields, which all slid a bit yesterday on what seemed to be a profit-taking move after that massive runup following the NFP and ISM data, are a bit higher this morning, with Treasury yields up by 3bps and most of Europe seeing similar movements, between 2bps and 4bps.  As I wrote above, this story remains all about inflation’s future, and as data comes in to add to the conversation, I suspect that will be the key mover going forward.

Oil prices (+1.0%) are continuing their modest recent rebound with WTI touching $74/bbl this morning and Brent above $79/bbl.  Comments by the Biden administration that they would continue to attack Iranian proxy groups seems to have traders worried about an escalation.  But a more concerning story is that Ukraine has been targeting Russian refineries in an effort to degrade Putin’s cash flow.  They have already hit several and reduced capacity by 4%-5%.  If that continues successfully, then oil prices are going to go much higher.  This doesn’t seem to be in the bigger narrative right now, so beware.  As to the metals markets, they are all slightly softer this morning, but movement has been tiny.

Finally, the dollar is under a modest amount of pressure this morning, which given the rising yields and softer commodities, seems out of character.  Granted, the movements are small, with most currencies just 0.1% – 0.2% firmer vs. the dollar.  And this could also be profit-taking given the dollar’s recent rally.  After all, the euro remains below 1.08 and USDJPY above 148.00 so this is hardly a collapse.

Turning to the data today, the Trade Balance (exp -$62.2B) is this morning’s release and then after oil inventories, at 3:00 we get Consumer Credit ($16.0B).  As mentioned above, we have many more Fed speakers as well, and I sense that will be of far more interest to market participants.  I don’t anticipate anybody straying from the current theme of inflation has been falling nicely but they are not yet convinced.  If someone strays, that could move markets, but again, I see little to drive things today, or this week.

Good luck

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Nary a Doubt

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The two things we’re watching today
Are Jay and the new QRA
The pundits are out
With nary a doubt
That easing is coming our way

But what if this faith is misplaced
And Jay, at the presser, bald-faced
Says policy ease
Is not what we please
And we’ll not get there in great haste

Reading the Fed Whisperer, Nick Timiraos of the WSJ, this morning was enlightening only to the extent that everybody he interviewed demonstrated they have no idea what will happen, and merely described what they would like to see.  Now, in fairness, I don’t think Powell himself really knows how things are going to play out as we continue to see mixed pictures on the economy.  For every strong datapoint (e.g., GDP, JOLTS, Case Shiller) indicating that there are many potential inflationary pressures extant, we see some softer data points (e.g., PCE, Empire Manufacturing, Dallas Fed) that indicate policy is excessively restrictive.  While it is very clear that the Fed will not adjust policy today, a look at Fed funds futures shows that the market is pricing in a 45% chance of a cut in March.  A month ago, that was over 70%, so Powell must be a bit happier, but 6 weeks is such a long time in this context, anything can happen between now and then.  And, oh yeah, the market is still pricing in 6 cuts this year.

Of course, long before the FOMC statement and Powell presser this afternoon, the Treasury will release its QRA and the market will learn if Secretary Yellen is going to continue down her recent path of leaning toward more T-bills and less coupons.  Based on her continuous comments that the soft landing has been achieved and inflation is no longer a problem, it seems quite clear that she wants to see the Fed cut rates soon.  After all, lower interest rates take pressure off the budget deficit, which is entirely her baby at this point.  Interestingly, she could essentially force Powell’s hand in this situation as follows:

1.     Issuing a high percentage of T-bills will lead to
2.     Reducing the RRP balances and bank reserves which will
3.     Force the Fed to respond by slowing/ending QT to prevent any systemic problems like seen in September 2019

Remember, we have already heard from Powell, as well as Dallas Fed President Lorie Logan, whose previous role was at the NY Fed overseeing the Fed’s reserve portfolio, that the time to discuss slowing or ending QT was fast arriving.  By itself, that is a policy ease, but it would also be a signal that further changes were on their way.  In fact, a continued heavy reliance on T-bill issuance would have two vectors to support the bond market; ending QT reduces the amount of bonds the market needs to absorb and reducing new supply by itself will do exactly the same thing.  At least for as long as inflation remains quiescent.  And in the end, that remains the biggest unknown, inflation.  All these plans and ideas revolve around the premise that the Fed has won its inflation fight.  But I ask you, what if they haven’t?

Too much digital ink has been spilled already on the inflation question and the two camps remain at distinct odds.  Forgetting all the conspiracy theorists who claim inflation is really 10% or more, and looking only at serious economists and analysts, while all agree that the rate of inflation has fallen from its peak levels in the summer of 2022, there is still a pretty even split between the two sides.  While I fall on the side of stickier inflation than the market is pricing, I can understand the other side of the story.  But the point is, there are two very real sides to the story and the outcome remains unwritten.  However, if inflation does remain stickier than the doves believe, it will destroy their entire thesis of why the Fed should be easing policy.  Given the stock market is making new highs regularly, I suspect investors and traders have largely bought into the ‘inflation is over’ view.  Just be careful if it’s not.

Ok, as we await today’s activities, let’s look at what happened overnight.  Following a mixed session in the US yesterday, Asian markets turned back the clock a few weeks with the Nikkei (+0.6%) continuing its longer-term rally while both the Hang Seng (-1.4%) and CSI 300 (-0.9%) revert to their losing ways.  It seems that investors simply do not believe that President Xi has either the ability or willingness to do anything to support the stock market there, at least, if not the economy.  I believe it would be a mistake to believe he is not willing, which calls into question exactly what they are going to do to prevent things from starting to impact the economy more negatively.  And perhaps we have seen the first steps.  The other noteworthy story in the WSJ this morning was about how Chinese authorities are “discouraging” negative takes on the economy from being published and instead telling news outlets to publish stories about the bright prospects there.

Moving on to Europe, the main indices have moved very little thus far today after a mixture of data showing inflation in Germany and France continue to decline but Retail Sales in Germany (-1.6%) and Switzerland (-0.8%) and Industrial Sales in Italy (-1.0%) all falling sharply in December.  Given the weak GDP data yesterday on the continent, none of this can be surprising.  Finally, US futures are mostly lower this morning, led by the NASDAQ (-1.0%) despite (because of?) what seemed to be solid earnings from Microsoft and Alphabet.  In the end, though, I sense that investors are far more focused on the QRA and FOMC right now.

Treasury yields are unchanged this morning but that is after a 4bp decline yesterday and we have seen European sovereign yields slide this morning as well, between 1bp and 3bps, which seems to be a catch up move to the Treasuries.  I must mention Australian government bonds, which saw yields tumble 13bps overnight on the back of a much softer than expected CPI reading which has the market talking rate cuts there again.  Finally, JGB yields edged 2bps higher, despite weaker than expected Retail Sales and IP data.

Oil prices (-1.1%) are backing off this morning after another positive day yesterday and a very strong month of January, where WTI rose > 9%.  (My take is that will not help the CPI data when it comes out in a few weeks’ time.)  Meanwhile, metals prices are trading near unchanged on the day as traders here are also awaiting the new information.

It should be no surprise that the dollar is, net, little changed this morning on the same premise of waiting for Godot Powell.  Looking at my screen, I don’t see any currency that has moved more than 0.3% in either direction so really no information yet today.

In addition to the QRA and FOMC meeting, we see the ADP Employment Report (exp 145K), the Employment cost Index (1.0%) and Chicago PMI (48.0).  Careful attention should be paid to the ECI as the Fed focuses on that metric for wage inflation data.  As an indication, prior to the pandemic, that index averaged around 0.6%, but since then, it is more like 1.0% on a quarterly basis.  That annualizes to more than 4% and will maintain upward pressure on inflation if it stays there.  Just something else to keep in mind.

If pressed, I believe that the QRA will show reduced coupon issuance and Powell will be more dovish than not.  While we know the Treasury is political, by definition, and will do everything in its power to stay in power and get re-elected, my take is the Fed is in that camp as well.  I would not be surprised to see a more dovish take this afternoon after the QRA this morning.  And initially, at least, that tells me the dollar will trade back toward its recent lows ceteris paribus.

Good luck
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