Tag Archives: #inflation

Jay’s Motivation

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The Keynesian view of inflation
Claims growth is its major causation
If that is the case
Then given the pace
Of growth, what is Jay’s motivation?
 
Instead, ought he not be concerned
Inflation will soon have returned?
Or does he believe
That he can deceive
The market without getting burned?

 

Another week passed with another set of confusing data.  But more important than the data’s inconsistency is the inconsistency in the arguments made by those desperate for the Fed to cut rates.  For instance, former NY Fed president Bill Dudley wrote a widely read article for Bloomberg saying that he had suddenly become a convert and that the Fed needed to act this week and cut rates.  Granted, he wrote this article the day before the much hotter than expected GDP data was printed, but nonetheless, he had been a staunch hawk and changed his feathers.  And he is not alone, with a number of other high profile financial personalities (I’m looking at you Claudia Sahm) in the same camp.

But I would ask them the following: since you are strong proponents of Keynesianism which describes inflation as a direct result of strong growth and labor markets, given that GDP is running at 2.8% annualized, double Q1’s pace and above trend, and a federal government budget deficit that is approaching 7% despite that growth, and the latest PCE data showing that services inflation remains quite robust (the 6-month level has risen to 5.4%), why do you think the Fed should cut rates?  By your own thesis, inflation is more likely to rise than fall given the economic strength.  Alas, either no journalist will ask that question, or no Fed official will answer. 

At the same time, those analysts who have been calling for a recession in the near future, continue to dig through the better-than-expected data releases and find the weak points to make their case.  Here’s the thing, Powell and company cannot point to yet another subindex of the major data points and claim that is why they are cutting.  He remembers far too well his focus on so-called super core (core ex housing) with the expectation that housing was the problem and if he removed the part of the index that was rising, the rest of the index would be lower.  Alas for his finely tuned plans, that number continues to power along at 4.0% or higher.  He will not make the same mistake again and focus on some obscure view.  

At this point, there is certainly no reason for the Fed to act this Wednesday, and unless the economy essentially falls out of bed by September, it will be difficult to make that case as well.  This is not to say they won’t cut in September come hell or high water, just that if the economy proceeds as it currently appears to be doing, there will be no justification.  But just to put an exclamation point on the likelihood a cut is coming in September, this morning the Fed whisperer, Nick Timiraos, told us that is the case in his latest missive for the WSJ.

In addition to the Fed meeting this week, we also hear from Ueda-san and the BOJ on Tuesday night and Governor Bailey and the BOE on Thursday morning.  Given the near certainty that the Fed is going to remain on hold this week, arguably the BOJ is the far more interesting meeting, at least for financial market cues.  Remember, the narrative has been that the BOJ was finally going to start to “normalize” their policy, lifting interest rates above 0.0% and start to reduce their ongoing QQE program.  Now, this has been the story since last October, and while they did exit the NIRP stage back in March, there has been nothing since then.  Not only that, as I highlighted last week, inflation in Japan is already slowing with the current policy.  

In addition, the yen, while it has backed away from its recent highs (dollar lows) by about 1%, is far from its worst levels and appears to be trending slowly higher, exactly what they want.  I see no case for a rate hike here, although we will certainly hear about how they may modify their QQE actions going forward.  (As an aside, for those with JPY exposures, 152.00 is a very critical level in the market’s perception and a break below that level could well lead to a significant decline in the dollar.)

Lastly, the BOE is going to cut by 25bps.  Given that the ECB has already cut, as has Switzerland and Canada, they will not be able to hold out any further.  I don’t think we need any rationale beyond this to believe Bailey will act.

Ok, let’s look at the overnight market activities.  Friday, you may recall, US equities rebounded sharply from the short-term correction and Japanese shares (Nikkei +2.1%) followed right along, as did the Hang Seng (+1.3%) and almost every other major market in Asia save one, China (CS! 300 -0.5%) as there continues to be a distinct lack of progress on the economy there.  In Europe, the situation is mostly positive as both the DAX (+0.4%) and Spain’s IBEX (+0.6%) are rallying nicely but the French (CAC -0.1%) are suffering a bit, perhaps because of the seemingly constant mishaps regarding the Olympics and the nation’s infrastructure.  This morning, major internet connections were severed around the country, although backups are now working, which added to a dramatic blackout over the weekend and the high-speed rail terrorist arsonist attacks late last week.  But here at home, US futures are firmly in the green (+0.4%) at 6:15am.

In the bond market, euphoria is the story as virtually every major bond market has rallied with yields falling around the world.  Treasury yields are lower by -4bps while across European sovereigns, we are seeing declines of between -5bps and -7bps across the board.  Even JGB yields (-4bps) have fallen, perhaps another signal that the BOJ is unlikely to be acting this week.

In the commodity markets, oil (-0.3%) cannot seem to find any support of note despite a significant inventory draw last week and an escalation in events in the middle east over the weekend.  For the past year, oil has traded between $70/bbl and $90/bbl and we continue to trade in that range with no exit in sight.  We will need to see some very significant economic changes, either a sharp recession or a giant rebound in China, to break out of this range I believe, neither of which seems like a near-term phenomenon.  In the metals space, gold (+0.3%) continues to find support even after a sharp decline a couple of days last week, with spot hovering just below $2400/oz.  This morning, silver (+0.75%) is also rallying but copper (-1.1%) is in a sharp downtrend, despite the news that the workforce at the world’s largest copper mine, Escondida in Chile, is preparing to go on strike.  

Finally, in the currency markets, despite the lower yields everywhere and the generally positive risk environment, the dollar is higher nearly across the board.  Both the euro and pound are softer by about -0.2% and we are seeing the EEMEA currencies following suit with declines on the order of -0.4% across this bunch.  USDJPY is little changed this morning although CNY (-0.1%) is edging lower again after the PBOC’s recent efforts to prevent a sharp decline in the wake of their rate cuts.  Interestingly, the outlier this morning is NOK (+0.3%) despite oil’s decline and there is no obvious catalyst for this movement.  One other currency that is bucking this trend is AUD (+0.1%) which while not much higher this morning, given it has been falling sharply every day for the past two weeks, seems to have found a bottom.  That movement is highly linked to the JPY strength as AUDJPY is a favorite carry trade for many in both the institutional and retail spaces.  If USDJPY does break through that 152 level look for AUD to continue its decline.

On the data front, we know it is a big week, but here are the details:

TuesdayCase Shiller Home Prices6.6%
 JOLTS Job Openings8.03M
 Consumer Confidence99.5
WednesdayBOJ Interest Rate Decision0.1% (unchanged)
 ADP Employment149K
 Treasury QRA 
 Chicago PMI44.5
 FOMC Rate Decision5.5% (unchanged)
ThursdayBOE Rate Decision5.0% (-0.25%)
 Initial Claims236K
 Continuing Claims1860K
 Nonfarm Productivity1.7%
 Unit Labor Costs1.8%
 ISM Manufacturing49.5
 ISM Prices Paid52.5
FridayNonfarm Payrolls175K
 Private Payrolls150K
 Manufacturing Payrolls-2K
 Unemployment Rate4.1%
 Average Hourly Earnings0.3% (3.7% Y/Y)
 Average Weekly Hours34.3
 Participation Rate62.5%
 Factory Orders-3.0%
 -ex transport+0.3%

Source: tradingeconomics.com

Obviously, an awful lot to consume and digest this week with the central banks and then NFP.  In addition to all that, we have a significant amount of earnings data coming from some big names including Apple, Amazon, Meta and Microsoft.  Certainly, the strong expectation is for the Fed to remain on hold and prepare the market for a September cut.  That is already priced into the futures market, so much will depend on the tone of the statement and the press conference following the meeting.  As such, my sense is the real unknown is the BOJ early Wednesday morning, but I suspect they leave rates on hold.  If they do hike, I would look for USDJPY to break that key support level of 152, so that feels like the biggest risk heading into the week.

Good luck

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Ending Debates

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There once was a banker named Jay
Who lived deep inside the Beltway
His words, when he spoke
Would sometimes evoke
A dovish response on the day
 
On Monday, we all got to hear
His views, and to some he was clear
Quite soon he’ll cut rates
Thus, ending debates
‘Bout ‘flation the rest of the year

 

While the market awaits this morning’s Retail Sales data (exp 0.0%, 0.1% ex autos), the focus for most traders and investors has been on Chairman Powell’s speech and discussion yesterday at the Economic Club of Washington DC.  The following headlines came from his prepared remarks and were highlighted all over the tape:

*POWELL: LAST THREE INFLATION READINGS DO ADD TO CONFIDENCE 

*POWELL: LABOR MARKET ESSENTIALLY NO TIGHTER THAN PRE-PANDEMIC 

*POWELL: JOB MARKET DOESN’T HAVE SLACK, ESSENTIALLY EQUILIBRIUM 

Then, following up in a Q&A, the money lines were these, “Now that inflation has come down and the labor market has indeed cooled off, we’re going to be looking at both mandates.  They’re in much better balance.”  

Not surprisingly, the market took this as confirmation that rate cuts are coming soon, although the futures market continues to price September as the likely first move.  While the meeting in 2 weeks has only a 9% probability priced in for a 25bp cut, looking at September’s pricing, 25bps are guaranteed and there are now some traders/investors looking for a 50bp cut, with that probability at 12.5%.  

Personally, I think there is a better chance of a July cut, especially if the PCE data next week are as soft as the CPI data were last week, than a 50bp cut in September.  My sense is that to get 50bps in September we would need to see the Unemployment Rate rise to 4.7% by that meeting with NFP pushing toward zero.  And while anything is possible, that seems highly unlikely in terms of the speed of the adjustment for those economic data series.  Other than the pandemic, even during deep recessions in the past, the rate didn’t rise that quickly.

As such, the market is now quite comfortable with the idea that the long-awaited initial rate cut will be here before the Autumnal equinox.  So, if that is the case, what does it mean?

One cannot be surprised that equity markets remain buoyant as we continue along the goldilocks trail of solid growth with slowing inflation.  Cutting rates into this environment will just add fuel to the equity fire.  There has been much made in financial discussions about the recent performance of small-cap stocks during the past several sessions.  It seems they have finally awoken from their deep slumber and have performed quite well, better even than the mega-cap tech names.  This has generated great excitement and we have seen several analysts raise their equity forecasts ever higher.  It seems that S&P 500 at 6000 is now a conservative view!

In the Treasury market, the yield curve has been slowly reverting to its more normal shape with 2-year yields falling more rapidly than 10-year yields.  This is the bull steepening that many had been anticipating, where yields overall decline, it’s just that the front end of the curve falls faster than the back.  History has shown that this type of movement typically foreshadows a recession, as the steepening accelerates when the Fed is slashing rates as the economy heads into a tailspin.  But maybe this time is different.  Ultimately, it can be no surprise that the yield curve is moving back to its normal shape of long-term yields higher than short-term yields.  After all, this inversion has been the longest in history.  I am just concerned that the speed of the onset of the coming recession may be much faster than most people assume.

As to commodity markets and the dollar, if the Fed is moving into a policy easing cycle, then commodity prices, especially precious metals and energy, ought to rally from here.  There may be a delay in industrial metals as a weak economy will weigh on demand there.  And the dollar will likely have a considerable down leg as well, although it will be tempered as central banks elsewhere around the world feel emboldened to be more aggressive with their own policy easing.

So, with that as a framework ahead of any potential future Fed actions, let’s look at what happened in the immediate wake of the Powell comments.  (As an aside, SF Fed President Daly also spoke yesterday and reiterated her concerns over the rise in the Unemployment Rate, indicating she was ready to cut.  Too, Chicago Fed president Goolsbee explained he was on the same page.)

Of course, given the Powell commentary, it is no surprise that US equity markets rallied yesterday with a new record high close from the DJIA although neither the NASDAQ nor S&P 500 could hold their record highs into the close.  Nonetheless, it was a strong day in the US markets.  In Asia, though, the picture was more mixed with the Nikkei (+0.2%) edging higher alongside a small move higher in USDJPY, and mainland Chinese shares (CSI 300 +0.6%) also gaining on hopes for some positivity from the Third Plenum.  But the Hang Seng (-1.6%) fell on fears of a Trump victory and the imposition of more tariffs on goods from there. The rest of the APAC space saw mixed reviews with some gainers (Taiwan, New Zealand, Korea) and some laggards (Australia, Malaysia, Singapore) although most of this movement was in small increments, 0.25%-0.35%.

European bourses, though, are having a tougher day as they are all lower on the session.  It seems that concerns over a Trump victory are manifesting themselves in concerns over European sales into the US or the imposition of tariffs here as well.  Adding to the misery, German ZEW data revealed a turn back down after several positive months, as concerns over the political situation in France and declining exports there weighed on the reading.  The upshot is that there is weakness everywhere, led by the CAC (-0.8%) in Paris and the IBEX (-0.8%) in Madrid.  (I think I wrote that exact sentence yesterday!). In the end, after a nice run as investors started to bet on ECB rate cuts, that story seems to be diminishing.  As to US futures, at this hour (7:30) they are modestly firmer, 0.2% or so.

In the bond market this morning, it appears that everyone around the world is excited about the possibility of Fed rate cuts as yields are lower across the board.  Treasury yields are down 6bps and European sovereign yields have fallen between 3bps and 5bps.  Even JGB yields slid 3bps overnight.  As has been the case for quite a while, the US yield story leads the global yield story.  If the Fed is going to start to cut, I expect that yields around the world are going to decline further, at least until inflation returns.

In the commodity markets, oil (-1.6%) is under pressure after weak oil demand data from China overnight undermined hopes that the Third Plenum would result in more government stimulus from the Xi government. This weakness is evident in industrial metals as well with both Cu (-0.65%) and Al (-1.0%) sliding further. However, precious metals are responding as one would expect to rate cuts, especially with inflation still around, as both gold and silver higher by 0.7% this morning, taking gold to new all-time highs.

Finally, the dollar continues to range trade overall with the DXY little changed on the day and hanging out just above 104, which happens to be its 60-year average!  While most currencies in both the G10 and EMG blocs are within +/-0.2% of yesterday’s closes, the one outlier is ZAR (+0.8%), which seems to be responding to some domestic plans to increase infrastructure investment in conjunction with private companies.

Other than the Retail Sales data mentioned above, there is nothing of note on the calendar today, although we will hear from new Fed governor Adriana Kugler.  At this point, I think it is becoming clear that the entire FOMC is on the same page; higher for longer is dead, long live the beginning of policy ease.  It is setting up to be a quiet session although I expect to see continues support for rate sensitive products like equities and precious metals.  The dollar, though, seems stuck as every central bank is ready to cut!

Good luck

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Some Mystique

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The Chairman is ready to speak
To Congress, and there’s some mystique
Will he indicate
The Fed’s favorite rate
Is likely soon in for a tweak?
 
Or will Chairman Powell explain
Inflation continues to drain
The ‘conomy’s health
And with it the wealth
He’s garnered through much of his reign

 

With recent elections behind us, market participants now turn their attention to Chairman Powell and his testimony today before the Senate Banking Committee and tomorrow before the House Financial Services Committee.  Of course, all eyes and ears will be searching for clues that the recent spate of softer than expected economic data has been sufficient to allow him, and his FOMC brethren, to gain the necessary confidence to cut the Fed funds rate.  Recall, to a (wo)man, every speaker has indicated that things were looking pretty good, but that they needed to see several months of this type of economic data before acting.

Lately, the punditry has become far more vocal about the possibility of a recession, with a number of well-known analysts claiming we are already in that state.  They point to the employment situation, notably the discrepancies between the establishment and household surveys.  Their argument revolves around the idea that the number of people working continues to decline despite the claim that there are more jobs being created.  It is true that job growth has been driven by an increase in part-time work, so this is not impossible.  And it is also true that when part-time work is ascendant, it typically signifies a weaker economy.

These same pundits point to the discrepancy between GDP and GDI (Gross Domestic Income) which ostensibly measure the same thing from different sides of the ledger.  Over the past year and change, as can be seen from the below chart, GDP has been growing at a faster rate than GDI with the difference between the two now at 2.3% of GDP.  

Source: St Louis Fed FRED data base

Putting that in context, the most recent Atlanta Fed GDPNow forecast for Q2 2024 has fallen to just 1.5% annual growth.  The implication is that GDP growth may well be negative.  Over time, these two measures get revised so that they are the same, but this particular discrepancy is both wider than normal and has been ongoing for a relatively long time in the history of the two.  Something is amiss and many pundits believe that the result will be GDP will be revised lower to match GDI rather than the other way around.  In other words, GDP growth is slower than reported and the chances we are currently in a recession are greater.

Of course, the other side of the story is also widely believed by other pundits who point to the consumer, which as evidenced by yesterday’s Consumer Credit data, continues to spend aggressively.  They also rely on the continued growth in the NFP data as a key indicator of economic activity and remain confident that the economy is simply in a slow patch during a continued growth period.

Now, it seems to me that the Fed are likely rooting for a bit more aggressive economic slowdown as that would give their models the signal that inflation is well and truly under control.  Perhaps Chairman Powell will give us those hints this morning, although he will certainly not explain that outright to the Senate.  (The one certainty from this morning’s testimony is that certain Senators from the Northeast are sure to rail at the current level of interest rates and berate Mr Powell for not having cut them already.)  In any event, that is really all we have on the calendar today, and likely the biggest news until Thursday’s CPI release.  After all, tomorrow’s House testimony will be identical by Powell, although we can look forward to even stupider questions from the likes of Representatives Maxine Waters and Ayanna Pressley.

And so, to markets.  Yesterday’s lackluster US session has seen a mix of results elsewhere in the world.  In Asia, the Nikkei (+2.0%) rallied sharply to new all-time highs, on the back of tech share enthusiasm and the AI story as well as the still weak JPY.  While the BOJ is slated to meet later this month, there is no clarity as to whether they will tighten policy given the still mixed data from Japan.  As well, Chinese shares (+1.1%) and Australian shares (+0.9%) both had solid performances although the Hang Seng was unable to gain any traction and was unchanged on the day.

In Europe, all is red this morning, led by the CAC (-0.8%) as it seems investors are beginning to understand that the electoral outcomes may not have been net beneficial for both the French and UK economies.  While the two nations have different issues (no leadership in France, a socialist one in the UK) I fear that both nations will have manifest economic problems going forward when it becomes clear that increased spending is unaffordable.  But for now, absent any additional data, investors are lightening up on exposures there.  US futures, though, are edging higher at this hour (8:00).

In the bond markets, yields are starting to turn higher again despite some lackluster economic data.  Treasury yields are higher by 2bps and across the UK and Europe, yields are higher by 3bps to 4bps universally.  This means there have been no changes to the spreads of OATs to Bunds, but it may not be that welcome overall.

In the commodity markets, oil (-0.4%) remains under pressure as concerns over US production being reduced by Hurricane Beryl have diminished now that wind speeds have fallen after landfall.  It did not impact the offshore drilling significantly.  As to metals markets, after a rough day yesterday, this morning both precious and industrial metals are little changed overall, arguably awaiting the next key catalyst, whether that is from Powell or CPI or something else.

Finally, the dollar is a bit firmer this morning across the board.  Both the euro (-0.15%) and the pound (-0.15%) have performed surprisingly well lately given the political backdrop.  Perhaps that is a hint that politics is not necessarily a key short-term driver of FX rates.  However, today, along with the rest of their G10 brethren, they are under pressure.  In the EMG bloc, ZAR (-0.6%) continues to demonstrate the greatest amount of volatility amongst the most traded currencies and is under pressure alongside metals prices.  As well, both HUF (-0.3%) and CZK (-0.4%) are showing their high beta response to the euro’s weakness.  However, today appears very much to be a dollar day, not a currency day.

The NFIB Survey was released at a better than expected 91.5, although that level remains in the lowest decile of readings in the history of the series.  In addition to Powell, we hear from Vice-chair for supervision Barr as well as Governor Bowman during the day, but really, it is all about Powell.  Personally, I doubt he tells us anything new and do not expect him to hint strongly at a rate cut coming soon.  However, if he does, look for the dollar to decline sharply.

Good luck

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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

Posted on by

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

Adf

Thoroughly Schooled

Posted on by

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

Adf

None Be Unique

Posted on by

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

Adf

Jejune

Posted on by

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

Adf

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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