Tag Archives: #inflation

Impuissance

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The world now awaits the response
Of Israel, which at the nonce
Has traders concerned
Restraint will be spurned
While mullahs pray for impuissance

Thus, oil continues to rise
And it oughtn’t be a surprise
The talk that inflation
Achieved its cessation
Has slowed while concerns crystalize

The most important market story this morning, I would contend, is the potential response by Israel after Iran’s missile attacks yesterday.  While only a handful of the approximately 180 missiles breached the Israeli aerial defenses, some damage was inflicted.  Israel has promised a response at their leisure and history has shown they have been effective in inflicting greater damage than they receive.

The major market concern is that Israel will attack Iran’s oil production capability, something which would certainly drive oil prices, which have spiked more than 8% in the past two sessions, higher still.  Currently, Iran is producing about 3.27 mm barrels/day, a solid 3% of global production and consumption.  Given the highly inelastic nature of the oil price, any attack there would have a substantial impact, at least in the short term.  Remember, though, that the Saudis have something along the lines of 3mm barrels/day of production shut in as OPEC+ has tried to support the price.  I expect that they would be able to bring that online quite quickly, so any price move would be short-lived.  The downside, though, is that it would use up the available spare capacity so any other event, say another hurricane which shuts in Gulf of Mexico production, would have an outsized impact.  Net, a response of that nature may only have a short-term impact on the price but would lead to more fragility overall.

As well, I am confident that the Biden administration is really working to convince Israel to leave the oil assets alone as during the campaign, a spike in oil, and by extension gasoline, prices will not be a welcome turn of events.  However, from Israel’s point of view, the destruction of Iran’s oil production capacity would result in a much weaker Iran, one that would have far more difficulty promoting their attacks on Israel.  At this point, we can only wait and see.

Away from that news, yesterday saw the PMI and ISM data releases which simply confirmed that global manufacturing activity remains in a slump.  The US report, printing at a weaker than expected 47.2, the 22ndmonth in the last 23 that the reading has been below the boom/bust line of 50.0, continues to drive concerns about economic weakness in the US.  Of course, manufacturing represents less than 25% of the economy directly, although many service jobs are dependent on the manufacturing sector.

Arguably, the perception of economic weakness that remains prevalent in the US stems from this situation, where manufacturing remains weak, and the ancillary activity typically driven by it remains weak as well.  These are the traditional blue-collar jobs, and it is those people who seem to be feeling the current economic malaise most severely.  In fact, this is as good an explanation as I can find for why despite some decent top line economic data, there are still so many people in the US who are highly stressed and living paycheck to paycheck.  While this is a macroeconomic discussion, it is also a key political discussion as it will highly likely be an important driver of voters come November.

As to the other topic that has traders engaged, central bank policy, the plethora of Fed speakers yesterday did nothing to alter any views on their next steps.  Currently, the Fed funds futures market is pricing a 35% probability of a 50bp cut in November, but still pricing an 85% probability that there will be 75bps of cuts by year end.  Now, this is less cutting than had been priced just a week ago, but that move was driven by Powell on Monday.  Given the amount of data that we will be receiving between now and the November meeting, including two NFP reports as well as a CPI and PCE report this month, and the first look at Q3 GDP, many views can change.

And that’s kind of it this morning.  Last night’s VP debate had no market impact, nor would I have expected it to do so.  Worries about the Middle East and questions about central bank policy are the current market drivers.

With that in mind, let’s see how things played out overnight after yesterday’s weak showing in US markets.  In Japan, the Nikkei (-2.2%) gave back Tuesday’s gains as the market tries to determine exactly how new PM Ishiba is viewing the economy and central bank.  In a statement, he indicated the government would work with the BOJ to achieve joint goals, and his initial hawkish perception has been walked back.  In fact, it is odd that Japanese stocks fell given JGB yields (-2bps) also declined alongside the yen (-0.7%) on those comments.  As to the rest of Asia, the Hang Seng (+6.2%) rocketed higher on the Chinese stimulus story (mainland markets are still closed for their holiday), but the other Asian markets that were open, including Korea, Malaysia and Indonesia, all saw selling pressure with declines on the order of -1.0%.

In Europe, continental bourses are all lower led by the DAX (-0.6%) and IBEX (-0.6%) although the FTSE 100 (+0.2%) has managed a small gain.  The UK move has been driven by energy stocks rallying on the Middle East story while the lack of energy stocks on the continent seems to be the key to losses as investors turn cautious.  As to US futures, at this hour (7:30), they are lower by between -0.2% and -0.4%.

Bond yields are lower this morning with Treasuries down -2bps while European sovereign yields have all fallen between -5bps and -6bps.  The weak PMI data there has increased the discussion about more aggressive policy ease from the central bank and the likelihood that inflation stays quiescent.

We have already discussed oil but a look at the metals markets shows that after a 1% rally yesterday, gold (-0.3%) is consolidating near its all-time highs, while both silver (+0.3%) and copper (+0.8%) continue to move higher.  For the latter two, everything I read is about how both metals are critical for building out the energy transition infrastructure and both metals are in structural shortage with stockpiles being utilized as mining output lags demand and getting new mines up and running is a decade long affair.  My take is both have further to rise.

Finally, the dollar is net little changed this morning after a very solid two-day rally.  Remember it was just Monday that I was discussing key technical levels in the DXY (100.00), EUR (1.1200) and GBP (1.3500).  Well, we have moved well away from all those levels as the dollar weakness story takes a break.  When Chairman Powell explained he was in no hurry to cut rates rapidly, that part of the narrative needed to change quickly…and it did.  So, this morning, aside from the yen’s weakness mentioned above, the other large mover is NOK (+0.7%) which is simply responding to the oil rally.  In fact, the commodity currencies are doing exactly what they are supposed to be doing with CLP (+0.5%) tracking copper and MXN (+0.4%) tracking both silver and oil.  ZAR (unchanged) is actually the surprise here although it has been rallying steadily since April on a combination of the strong metals markets and continued belief in a better economic situation based on the new government’s business friendly policies.

On the data front, this morning brings only ADP Employment (exp 120K) and the EIA oil inventories where further inventory drawdowns are anticipated.  We also hear from four more Fed speakers although given Powell’s lack of concern regarding the speed of cuts, it will be hard for these speakers to change the market perception in my view.  This leaves us with the big picture.  Right now, employment remains the most important data for the Fed and their policy views.  As such, this morning’s ADP is likely to have more importance than it ordinarily would, despite the limited correlation between this data and the NFP to be released on Friday.

It seems that there are some subtle changes in central bank views with market perceptions of FX moves impacted.  The Fed is now seen as not quite as dovish, while the BOJ and ECB are seen as a touch more dovish, hence the dollar’s gains against both the yen and euro.  However, I think the central bankers realize they are still feeling their way in the dark and will be slow to respond to outlier data, so this vibe seems likely to hold in the near term.

Good luck
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Not in a Hurry

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The committee is not in a hurry
Said Jay, but the bulls needn’t worry
‘Cause Jay knows what’s what
And he can still cut
Quite quickly and watch the bears scurry
 
Meanwhile, at all ports in the east
The longshoremen’s working has ceased
With them now on strike
We could see a hike
In costs soon with ‘flation increased

 

“Overall, the economy is in solid shape; we intend to use our tools to keep it there. This is not a committee that feels like it’s in a hurry to cut rates quickly.  Ultimately, we will be guided by the incoming data. And if the economy slows more than we expect, then we can cut faster. If it slows less than we expect, we can cut slower.”

These were the key comments by Chairman Powell yesterday at the National Association for Business Economics annual meeting in Nashville.  They were the very essence of the two-handed economist who explains both sides of an issue without drawing a conclusion.  However, it appears what the market heard was ‘the Fed’s only going to cut 25bps at a clip going forward’.  This was made evident by the fact that when he began speaking, we saw equity markets dip right away as per the chart below of the S&P 500, although as he continued, and made clear that they expected to continue to cut rates and support the economy, traders (and algorithms) decided things were fine.  

Source: Bloomberg.com

We also heard from two other Fed members, Atlanta Fed president Bostic and Chicago Fed president Goolsbee, who both explained 50bps could well be the appropriate next move if things don’t follow their current script perfectly.  Naturally, equity markets heard that news and were soothed, hence the result that all three major indices closed slightly higher on the day.

The other major story this morning is that the International Longshoreman’s Association, the union for dockworkers along the entire East Coast and Gulf of Mexico, have gone on strike as of midnight.  They are demanding a 77% increase in wages over the next 6 years as well as promises about the speed with which further automation will occur in order to save jobs.  While the Taft-Hartley act could be invoked by the president to force both sides back to the bargaining table and require the workers to get back on the job for the next 80 days, President Biden has chosen not to do so in an effort to polish his political bona fides with unions.

The ultimate impact of the strike will depend entirely on its length.  This was not a surprise and many retailers and other importers pre-ordered inventory to tide them over as the holiday shopping season gets going.  However, estimates range up to an economic cost of $5 billion per day for each day of the strike, and the longer it goes on, the bigger the problem because rescheduling once things are settled will be that much more complex.  Regardless of the timing, though, one can be pretty certain that this will pressure prices higher as either shortages of certain items develop, or the wage gains result in higher shipping costs which will almost certainly be passed through the value chain.  

Remember, while headline PCE fell to 2.2% last month, core remained at 2.7%.  In the CPI readings, headline is still 2.5% with core at 3.2%, and perhaps more disconcertingly, median CPI at 4.2%.  Powell’s decision to cut rates 50bps last month with GDP still growing at 3%, the Unemployment Rate at a still historically low level of 4.2% and inflation, whether measured as PCE or CPI well above 2.0% was quite aggressive.  If this strike lasts a while, more than one week, expect to see price pressures begin to build again and that is going to put the Fed in a very difficult position.

One last thing to consider is the fact that virtually every major central bank around the world is in easing mode now that the Fed has begun to cut despite the fact that growth remains in decent shape in most places (Germany excepted).  This morning’s Eurozone CPI data (1.8%, 2.7% core) was even softer than expected virtually guaranteeing more aggressive action by the ECB and of course the PBOC was hyperaggressive last week in their easing actions.  Yesterday, Banxico indicated they may begin to cut more aggressively after having started their easing stance with 25bp cuts, as inflation in Mexico continues to decelerate to their target level of 3% +/- 1%.  The point is that policy worldwide is easing, or even in the few places where it is not, e.g. Japan and Australia, they are not tightening at any great pace.  The upshot is there is greater scope for a rebound in inflation while the dollar and other currencies continue to devalue vs. real items like commodities and real estate.  That is another way of saying that prices in those two asset classes should continue to climb.  As to the fiat currency world, relative values will depend on the pace with which individual nations ease, but they will all sink over time.

So, how have markets responded to the latest news?  After the modest US gains yesterday, and remember China is closed all week, Japan (+1.9%) regained about half of Monday’s declines after Ishiba-san was officially named PM and he appointed and Abenomics veteran, Katsunobu Kato, as his FinMin, helping encourage the idea that the BOJ may not be quite as aggressive as previously thought.  The rest of Asia saw more gainers than laggards with Taiwan (+0.75%) the next best performer and a mix otherwise.  In Europe, the picture is mixed with some gainers (FTSE 100 +0.4%, DAX +0.3%) and some laggards (IBEX -0.6%, CAC -0.2%) after Manufacturing PMI data across the continent continued to show lackluster results with Germany falling even further to a reading of 40.6 although Spain’s reading jumped to 53.0.  I must admit the stock market outcomes seem backward although I can understand the German view that the ECB will be more aggressive, thus supporting stocks, but why that is not helping Spain is a mystery.  As to US futures, at this hour (7:20) only the DJIA (-0.35%) is showing any discernible movement.

In the bond market, after yields backed up 5bps yesterday over concerns that the Fed’s more aggressive stance would lead to inflation and the port strike would not help that situation, they are sliding this morning.  Treasury yields, after touching 3.80% during yesterday’s session are down to 3.74% this morning and European sovereign yields have fallen even more sharply, between -7bps (Germany) and -12bps (France) as traders and investors become convinced that the ECB is going to become more aggressive in their easing.  JGB yields also slid 1bp last night after Kato-san’s appointment.

It should be no surprise that metals prices are rebounding this morning given the decline in yields as well as the growing concerns over inflation.  So, gold (+0.5%) is leading the way higher but the entire group is higher on the session.  However, oil (-0.8%) remains under pressure as news of Israel’s ground incursion into Lebanon to root out Hezbollah seem to be ignored while news that Libya is getting set to restart production after a political settlement was reached there adds to the supply picture.  

Finally, the real surprise is the dollar, which based on yields and metals would have been expected to continue sliding, but instead has rebounded sharply.  In fact, yesterday, the DXY rallied virtually all day and that has continued this morning with the index now above 101.00.  You may recall I highlighted that it was testing the 100 level which is seen as a key support.  I guess there is no break coming today.  This morning, the dollar’s move is universal, rising versus both the euro (-0.5%) and pound (-0.5%) as well as the rest of the G10 save the yen which is unchanged on the day.  In fact, 0.5% is the magnitude of that move virtually all the other currencies in the bloc.  As to the EMG bloc, these currencies have also suffered by -0.5% or so regardless of the region with the CE4 the worst performers, averaging -0.7%, while Asian currencies were down more on the order of -0.3% and LATAM -0.5%.

On the data front, ISM Manufacturing (exp 47.5) and JOLTS Job Openings (7.655M) are the main features and we hear from four more Fed speakers (Bostic, Cook, Barkin and Collins) before the day is done.

It is hard for me to look at the current situation without growing concern that the Fed is in the process of making a catastrophic error by easing policy into the base of an inflation cycle that just got more impetus from a key labor situation.  In the end, it is not clear to me how the dollar will behave against other currencies in the short run, but I see only upside for commodity prices.  If things do get ugly, the dollar will be seen as the best of a bad lot, and as commodity demand grows, so will demand for the greenback in order to buy those commodities, but this is not a positive story.

Good luck

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More Money to Mint

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As an eagle soars
So too did the yen after
Ishiba-san won

 

Political change in Japan is far less bombastic and exciting than here in the US as evidenced by the election of Shigeru Ishiba as the new leader of the Liberal Democratic Party (LDP) last night.  Given the LDP’s large majority in the Diet (Japan’s parliament), as the new leader, Ishiba-san is now all but certain to be the new Prime Minister. This will likely be confirmed by a vote as early as next Tuesday, but sometime very soon regardless.

Ishiba’s background, a party veteran and former defense minister, seems to have been the right focus at the right time as strains with China have recently increased and the electorate (LDP members, not the general population) are clearly hearing about security concerns more than other issues.  The implication is that economic issues were not the driving force here, but in that vein, Ishiba’s views appear to be to allow the BOJ and Governor Ueda to continue their normalization process, finally ending the decade plus of Abenomics that worked to raise inflation.  

Now, as it happens, last night Tokyo inflation was released with the headline falling to 2.2% and the core falling to 2.0%, as expected.  It also appears that one of his key opponents, Sanae Takaichi, had been an advocate of pressuring the BOJ to slow its policy normalization, so with the results, market participants reacted swiftly, and the yen rallied sharply on the news as per the below chart while the Nikkei after an initial sharp decline, rebounded and closed higher by 2.3%.

Source: tradingeconomics.com

Going forward, it seems unlikely that the yen is going to be a focus of the new Ishiba administration.  Rather, he is clearly focused on defense strategy so Ueda-san will be able to continue his normalization efforts at his own pace.  As evidence, JGB yields stopped their recent slide and backed up 2bps overnight.  I suspect that we will see a very gradual move higher here with key drivers to be purely economic issues rather than political ones, at least for a while.

This morning, the PCE print
Will help give another key hint
To whether the Fed
When looking ahead
Will soon start, more money, to mint

The other story for the day is the PCE report to be released at 8:30. Current expectations are for a 0.1% M/M, 2.3% Y/Y rise in the headline number and a 0.2% M/M, 2.7% Y/Y rise in the ex-food & energy reading.  If these are the realized outcomes, the trend lower in inflation will remain on track and all the Fed speakers will feel vindicated that the 50bp cut last week was appropriate.  But I think it is worthwhile to take a quick look at a chart of how this number (core PCE) has evolved over time to help us better understand where things are in relation to the pre-pandemic economy. 

Source: tradingeconomics.com

Now, while there is no doubt that we are well below the highest levels seen two years ago, it is not difficult to look at this chart and see a potential basing formation, well above the pre-pandemic levels.  In fact, today’s expectations on the core reading are for a bounce higher of 0.1% which would only reinforce the idea that we have seen the bottom in this reading.  Of course, any one month’s data is not definitive as everything is subject to revisions, and simply looking at the chart, it is easy to see both ebbs and flows in the data well before the pandemic.  But I continue to be concerned that the Fed’s very clear ‘mission accomplished’ attitude on inflation is a big mistake that will come back to haunt us all sooner than you think.

Ahead of the data, a look at the overnight session shows that the ongoing rally in risk assets that started with the Fed and has been goosed by China’s efforts this week, remains the dominant theme.  In fact, Chinese shares had another gargantuan session last night (CSI 300 +4.5%, Hang Seng +3.6%) as hedge funds who had been quite short the Chinese stock market prior to the announcements this week continue to scramble to cover those shorts as well as get long for the rest of the expected ride.  But away from China and Japan, the rest of Asia was far less excited with declines seen in India, Korea and Australia leading most indices lower there.  As to European bourses, they are firmer this morning led by the DAX (+0.8%) but green everywhere after preliminary inflation data for September from France and Spain saw declines well below expectations to 1.5% and investors increased the probability of an October ECB rate cut substantially.  While some ECB members remain concerned over the stickiness of services prices, which continue to hover above 4%, if the headline numbers are falling below 2%, I think it will be very difficult for Madame Lagarde to push back against another cut next month.  Meanwhile, ahead of the data, US futures are unchanged.

In the bond market, Treasury yields have edged lower by 1bp while European sovereign yields have moved a similar amount except for French OATs which have slipped 3bps.  The story about French debt yielding more than Spain, one of the original PIGS has gotten a lot of press and it seems deeper thinkers disagree with the idea and are buying ‘undervalued’ French OATs.  

In the commodity markets, oil (+0.15%) has finally stopped falling, at least for the moment, although the recent trend is anything but encouraging for oil bulls.  Crude is lower by -4.5% in the past week and -9.0% in the past month, clearly helping the headline inflation readings.  As to the metals markets, after another strong day yesterday, they are consolidating with very modest declines (Au -0.2%, Ag -0.1%, Cu -0.4%) although the trend in all three remains firmly higher.

Finally, the dollar, after several sessions under a lot of pressure, is also bouncing slightly, at least against most of its counterparts.  We have already discussed the yen’s gains, but vs. the rest of the G10, it is firmer by roughly 0.15% or so while vs. its EMG counterparts some are seeing losses  (CE4 -0.3% to -0.4%) while there are others with modest gains (ZAR +0.3%, MXN +0.4%).  For now, the trend remains for a lower dollar, and if we see a soft PCE reading this morning, I expect that to reassert itself as thus far, today’s price action appears more like a trading response to the recent weakness.

In addition to the PCE data, we also see Personal Income (exp 0.4%), Personal Spending (0.3%), the Goods Trade Balance (-$99.4B) and Michigan Sentiment (69.3).  Mercifully, on the Fed front, only Governor Bowman speaks, she of the dissent at the last meeting, although yesterday’s plethora of Fed speakers taught us nothing new at all.  

I don’t have a strong opinion as to how this data will play out, but I would caution that if PCE is firmer than expected, look for a hiccup in the recent euphoria over stocks and bonds, while the dollar consolidates its support.  However, if we see a softer print than forecast, watch out for a much bigger rally in stocks and a much weaker dollar.

Good luck and good weekend

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Scuppered

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There once was a time many thought
That equities had to be bought
Then, darn it, Japan
It scuppered the plan
And havoc is all that they wrought
 
So, last week, not greed, but fear, won
And risk assets ended their run
But now folks are sure
In fact, it’s de jure
That rate cuts, next month, are, deal, done

 

Congratulations everyone.  You made it through the end of the world!  I must admit, though, that on this side of that extraordinary event, things don’t really seem that different.  A quick recap reminds us that on July 31st, the BOJ surprised markets and raised interest rates by 15bps, taking their overnight funding rate to 0.25%, its highest level in 15 years.  Twelve hours later, the FOMC did not cut rates, as some had been advocating, but seemed to promise that a cut was coming in September.  Then, two days later, the US employment report showed substantially weaker jobs activity than expected.  Over the ensuing several sessions, USDJPY declined dramatically, falling nearly 10 big figures as can be seen in the first chart below.

A graph with numbers and a line Description automatically generated

Source: tradingeconomics.com

After an initial reflexive trading bounce, it was starting to slide again when, on August 6th, BOJ vice-governor Ichida explained that the BOJ would not, in fact, be aggressively tightening policy immediately.  The result was a relief rally and now USDJPY sits about halfway between the level prior to the rate hike and the low’s plumbed afterwards.

Perhaps just as interesting is the fact that the Nikkei 225 showed virtually the identical trading pattern, with its decline last Monday, August 5th, as the second largest single-day decline in its history.

Source: tradingeconomics.com

And yet, it is not hard to see that the trading pattern for both the Nikkei 225 and USDJPY are virtually identical, with the same catalysts.  In fact, we can look at other markets, 10yr Treasury yields and the NASDAQ come to mind, and see extremely similar price action.  (Alas, I couldn’t get the BOJ and Unemployment rate points on the combined chart, but you can see it is the same pattern.)

A graph of stock market Description automatically generated

Source: tradingeconomics.com

The one truism that holds is that during a time of stress, all correlations go to one!

But perhaps it’s time to consider, once again, the idea of recession.  As of now, there are still two camps:

  1. Recession is already here and started sometime in the late spring.  This is based on the declining trend in manufacturing activity, the rise in the unemployment rate (the Sahm Rule), the rising number of bankruptcies and increasing size of household debt along with delinquencies.  Constant downward revisions of previous data releases also weigh on the view, and of course, the yield curve continues to point to lower interest rates going forward, the implication being growth is slowing.  One last feature is the dramatic difference between GDP and GDI, two different measures of US economic activity that should show the same thing, however currently, GDI (Gross Domestic Income) is printing below 1% real growth.
  • Meanwhile, the soft/no-landing scenario remains popular amongst a different set of analysts.  Perhaps the most comprehensive discussion comes from Apollo Research’s Torsten Slok as he highlights the fact that real-time indicators like air travel, restaurant seatings, income tax withholdings and Retail Sales remain quite strong.  As well, the Atlanta Fed’s GDPNow is currently running at 2.9%, which certainly doesn’t appear to be pointing to a recession.

So, which is it?  Of course, that’s the $1 trillion question.  However, let us consider a few incontrovertible truths.  First, business cycles still exist.  Despite all the efforts by finance ministries and central banks to create an ever upward trajectory in economic activity, or more accurately because of those efforts, excesses are created and at some point, that growth is no longer sustainable.  In other words, governments and central banks blow bubbles and eventually they pop.  Second, not all parts of the economy grow at the same pace and respond to the same catalysts in a similar manner.  So, certain parts of the economy may be under pressure while others are doing fine.  Third, trees don’t grow to the sky.  There are no magic beans which grow that beanstalk ever higher.  Rather, at some point, gravity becomes a stronger force, and things return to earth. 

From this poet’s viewpoint, we are continuing to see sectoral weakness that has not yet tipped into general weakness.  We’ve all heard about commercial real estate and the problems ongoing in that sector.  As well, we’ve all heard the excitement about AI and the massive (over)investment that has been focused on that sector, supporting the companies at the heart of the story.  In between, there are many shades of grey with some areas holding up better than others.  But on an economy-wide basis, it seems likely that given the amount of ongoing fiscal stimulus that is still being pumped into the economy, overall, a recession will still be delayed further.

Perhaps the bigger problem for the economy is that inflation remains a very real phenomenon. As the WSJnoted this morning, it is the prices of things with which we cannot do without (e.g., food, shelter, insurance) that continue to rise, rather than the discretionary items, which seem to see prices ebbing.  Ultimately, the downturn will come, but you can be sure that the government, and the Fed, will do all they can to prevent it happening, at least before the election.

Ok, with that in mind, let’s look at markets overnight as well as what this week’s data releases will bring.  After modest gains in the US on Friday, with the early part of last week’s dramatic declines essentially elimiated, Asian equity markets were generally stronger (Korea, Taiwan, Australia) although Chinese shares continue to lag (CSI 300 -0.2%) as data showed that investment into China has turned to divestment from China for the second quarter of the past four. (see chart below).  This is obviously not a positive story for the Chinese economy or its equity markets.  As an aside, Japanese markets were closed for a holiday last night.

A graph of a graph showing the value of a stock market Description automatically generated with medium confidence

Source: Bloomberg.com

Meanwhile, European bourses are generally little changed, +/-0.15% or less except for the UK, where the FTSE 100 is higher by 0.5% despite hawkish comments from BOE member Catherine Mann warning against complacency on inflation and pushing back against the idea of consistent interest rate cuts.  Lastly, US futures are edging higher at this hour (7:15), up about 0.2% across the board.

In the bond market, yields are edging back up this morning, with Treasuries higher by 2bps and similar gains across all of Europe.  To the extent that government bonds are serving as havens again, the idea that equity markets are rebounding would certainly imply less demand for them.  The one place where yields continue to decline is in China, where 10-year yields are trading near the historic lows seen at the end of July, and clearly still trending lower, an indication that growth expectations are falling.

A graph with a line graph Description automatically generated

Source: tradingeconomics.com

In the commodity markets, oil (+1.25%) is gaining on the growing expectation that Iran is set to finally respond to Israel and launch a significant assault with fears this can grow into a wider conflagration and impact supply.  That fear seems to be bleeding into gold (+0.5%) as well, which is back toward its historic highs, and taking the entire metals complex (Ag +1.8%, Cu +1.1%) with it.

Finally, the dollar is mixed this morning, rising strongly against the yen (-0.7%) and CHF (-0.5%) but lagging the commodity currencies (AUD +0.5%, NZD +0.5%, ZAR +0.6%).  As to the more financial currencies, like EUR, GBP, CAD, they are little changed on the session.  Ultimately, the story remains driven by expectations of Fed activity with the market currently pricing a 50:50 chance of a 50bp rate cut come September.

On the data front, we do see important things this week as follows:

TodayNY Fed Inflation Expectations3.0%
TuesdayNFIB Small Biz Confidence91.7
 PPI0.1% (2.3% Y/Y)
 -ex food & energy0.2% (2.7% Y/Y)
WednesdayCPI0.2% (2.9% Y/Y)
 -ex food & energy0.2% (3.2% Y/Y)
ThursdayInitial Claims235K
 Continuing Claims1880K
 Retail Sales0.3%
 -ex autos0.1%
 Empire State Mfg Index-6.0
 Philly Fed7.0
 IP0.1%
 Capacity Utilization78.6%
FridayHousing Starts1.35M
 Building Permits1.44M
 Michigan Sentiment66.7

Source: tradingeconomics.com

In addition, we hear from several Fed speakers, with at least three on the docket, but I imagine we will get more than that.  Last week’s fears have been memory-holed.  The vibe this morning is that it was all the BOJ’s fault and that everything is going to be great.  Maybe that will be the case, but I remain a skeptic.  Just consider, if everything is great, why would the Fed cut rates?  And the one thing that seems clear to me is that a Fed rate cut is the base case for virtually everyone. I maintain if they cut, especially 50bps, the dollar will fall sharply.  But if that recession data doesn’t start to appear soon, some folks are going to need to change their views, and positions, regarding how things unfold.

Good luck

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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

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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

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