Tag Archives: #inflation

Pundits and Bores

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The fallout from Warsh’s decision
To leave rates without a revision
Has opened the doors
For pundits and bores
With hawks and doves set for collision

For some, Warsh has failed from the start
As they felt a rate hike was smart
But others explain
That under his reign
It’s markets that play the main part

For a no action outcome by the Fed last week, it certainly is interesting how much digital ink has been spilled discussing the outcome of that meeting and, depending on which side of the argument you fall, whether it was the right move or an error.  You know I have been of the belief that there will be zero rate hikes this year and nothing has changed that opinion yet.

There is a great deal of conversation regarding the Fed’s credibility and how despite Warsh’s tough talk about achieving their 2% inflation goal at his first meeting, by doing nothing last week, he has trashed that credibility.  My first thought here is, given the Fed has failed in its key objective for more than 5 straight years on its own terms, it is difficult for me to accept they had a lot of credibility left to trash.  But my second thought is to listen to the Chairman’s words about allowing the market to do its job, and not simply watch the Fed, and I realize there are an awful lot of analysts and pundits who don’t know how to do that and therefore are extremely uncomfortable now.  As I wrote last week, these folks get paid a lot of money by Wall Street and now they have to earn it.  So perhaps that explains the ongoing diatribes.

Much has been made of the fact that between the June and July FOMC meetings, US Treasury yields rose substantially as you can see from the below chart.

Source” tradingeconomics.com

At the close on Friday, they had risen 34bps in the 30-year and 28bps in the 10-year), although this morning, with oil prices (-5.6%) falling on the back of a renewed diplomatic initiative in Iran, both of those bonds have seen yields back off by 5bps. 

Now, one of the things that Warsh specifically explained in the press conference was that the market had raised rates already, effectively doing the Fed’s job for them.  And here is the point of departure, I believe, regarding the punditry viewpoint and the Warsh viewpoint.  Warsh has been explicit in saying he wants the Fed’s footprint in the markets to shrink.  He wants market participants to, “play the ball, not the referee”.  However, the pundits claim that the only reason rates rose was in anticipation of the Fed hiking rates.  

So, let’s try a little thought experiment.  Assume there was no Fed, instead that money supply was mechanically increased by 2% per year and that all interest rates were determined by the market.  Do you believe that in this scenario, a government running consistent extremely large deficits would not drive interest rates higher than they otherwise would be, without a central bank to officially do so?  I know I do.  Is that any different than the market pushing yields higher because they are concerned with excess supply of Treasuries and other inflation concerns?  

The Fed has had a major, and in Warsh’s (and my) view, too large impact on markets for a long time, since Black Monday in 1987.  Change is hard and the punditry does not like the fact that they are going to have to actually think and pay attention to many variables in order to have a viable view on things, so they are all crying and claiming Warsh is making a huge mistake.  While not surprising, I think they are completely wrong.  

It is also important to understand that the current yields in the bond market are anything but ordinary. Below is a chart I created with FRED data and included the long-term average 10-year yield since 1962, which happens to be 5.81%, more than 100bps above current levels.  For a very long time, a good rule of thumb for the 10-year yield was it should be approximate the nominal GDP growth rate, but we have gone through such a long period of financial repression, that idea faded away.  Perhaps that is coming back into vogue, so at the long-term average, we could see 3.8% GDP growth and 2.0% inflation.  And even today, it could represent 2.7% GDP growth and 2.0% inflation.  I don’t think anybody would be unhappy with that outcome.

My understanding is the task forces will not be reporting until early next year.  At the same time, I am convinced that Mr Warsh is very serious about making significant changes at the Fed going forward, and I applaud that.  But it is going to require him to convince 18 other people who have been inculcated in a process that has proven to be a failure but offers comfort to those people because they know how it works.  Change is very hard, and this will be harder than most.  One last thing, the biggest change is going to be the balance sheet.  The Fed continues to buy T-bills and expand the balance sheet as they continue to seek to maintain “ample” reserves, so banks have liquidity.  I would not be surprised if when we hear from Chairman Warsh at the Jackson Hole meeting at the end of the month, he indicates the Fed will stop buying bills at the next meeting moving further down the path of change.

Surprising comments
Bessent admitted the Fed
Joined the Japanese

The following statement released by Japan’s MOF is quite a surprise, at least the fact that they admitted to the action, something that has rarely been the case in the past.  

Some have made the point that given Japan is the largest holder of Treasury securities in the world (other than the Fed) and that they would need to sell their Treasuries to fund intervention, this was the driving force.  Certainly, the US is not keen to have holders sell their bonds at this point.  As you can see in the chart below, this intervention has had a larger impact than the previous bouts which were solo Japanese efforts.

Source: tradingeconomics.com

At the dollar’s low, the yen appreciated about 5% in the past two sessions, certainly a very large move.  One of the other things that was interesting was that ostensibly, the Treasury sold EURJPY, not USDJPY.  Perhaps they had extra euros lying around they no longer wanted.  According to BOJ data, it appears the Japanese spent something like $33 billion on the intervention, but I have no indication as to the US effort.

Joint intervention is pretty rare, with the last time being in the wake of the earthquake/tsunami at Fukushima in 2011 when the yen strengthened dramatically.  But it also has a better track record than solo intervention, although absent significant fiscal changes, on both sides of this equation, I suspect that within a few months, the yen will weaken again.

Ok, I feel like that’s enough for one morning.  The oil story, as I mentioned, is that the President has called off the mooted weekend attacks and diplomacy is back on the table.  Interestingly, the metals markets are not as excited by that with gold (+0.15%), silver (+0.6%) and copper (+0.75%) all higher, but not by very much, especially given the size of the decline in crude prices.  And product prices (gasoline -3.4%, heating oil -3.0%) are also sharply lower.

As also mentioned above, bond yields have backed off with European sovereigns sliding far more than Treasuries, between -6bps (Germany, Netherlands) and -9bps (UK, Italy, Greece).  However, JGB yields (+3bps) did not get the memo although I suppose that has more to do with the belief that the BOJ is going to be forced to hike rates as part of the joint US-Japanese currency efforts.

As to the equity markets, after Friday’s US rally, the picture in Asia was mixed, despite the oil price decline, although for Japan, a stronger yen is often a problem for Japanese equities.  The worst performers were Korea (-5.1%), Tokyo (-0.9%) and China (-1.0%) while much of the rest of the region followed the US higher (HK +0.5%, India +0.7%, Taiwan +0.6%, Australia +0.5%) with the smaller exchanges mostly higher as well.

In Europe, things are generally bright with Germany (+1.4%), France (+1.3%) and Spain (+0.75%) all nicely higher despite (because of) modestly weaker PMI data although the UK (0.0%) has not been able to overcome its PMI weakness.  Now, in fairness to the UK, its 51.9 reading, while weaker than last month and forecast, is still about the best in Europe.  As to US futures, they are all in the green, led by the DJIA (+0.8%) at this hour (7:00).

Finally, the dollar is kind of confused overall.  The big winner today is KRW (+1.0%) although that trade has been ongoing for more than a month and is approaching an 8% gain over that period.  The yen (+0.4%) continues to climb, albeit less aggressively, although the other G10 currencies are generally under pressure (GBP -0.15%, AUD -0.3%, CAD -0.2%, NOK -0.6%).

However, I must mention something that Alyosha wrote this morning in Market Vibes that is worth considering; two of the major positions in markets were short bonds and short yen.  Joint intervention by the US and Japan to sell EURJPY has likely forced a lot of covering in both of those markets and it would not be surprising to see more activity like that and further short covering.  Japan is the largest holder of French bonds as well as Treasuries and could easily sell those without a peep from the US.  

Ok, I have gone way over my daily quota this morning, although there were a couple of really big, and complex stories to discuss.  On the data front, today brings ISM Manufacturing (exp 54.0) and I will delve into the rest of the week’s data, including Friday’s payroll report tomorrow.

Good luck

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Dust in the Wind

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A line has been drawn
Is it steel reinforced? Or
Just dust in the wind?

Shortly after 9:30 yesterday morning, the BOJ entered the FX market aggressively selling dollars as you can see in the chart below.  While the amount sold is unknown at this time, it was likely pretty large, ~$10 billion – $15 billion would be my guess.  In addition to the sales, though, apparently the Fed called around the Street “checking rates”, although my understanding is the Treasury didn’t actually sell any dollars.

Source: tradingeconomics.com

Regardless, the signal of an approved, if not joint, intervention is powerful and I expect that the market will take some time before pushing the dollar back higher again.  Now, one of the themes yesterday was that the BOJ would also raise interest rates at their meeting last night in a surprise move as a way to reinforce this action.  I believe if they had done so, it could have been quite effective and we would have seen another sharp leg lower, as well as an overall reduction in pressure on the yen.  But they did nothing with their base rate remaining at 1.0% and, as you can see from the chart, the drift has already begun for the yen to weaken once more.

As I have maintained throughout this process, absent policy changes of substance, and at this point in Japan that includes fiscal as well as monetary, pressure on the yen is very likely going to be the norm.  Of course, if the Fed really does begin to ease policy at some point, that will alter opinions and I imagine soften the dollar universally.  

The pundits are still really pissed
That Warsh, their concerns, has dismissed
Get ready to hear
That Doomsday is near
If Warsh keeps ignoring their gist

Since we seem to be in an interlude in the war in Iran and the Middle East, so oil markets remain quiet and there has been little news from the White House, the punditry has continued its focus on Fed Chair Warsh and all the things they hate that he is doing.  This is well summed up in this morning’s WSJ article titled, ”Kevin Warsh’s Honeymoon with the Bond Market Is Already Over”  interestingly, this was not written by Nick Timiraos, but rather by Sam Goldfarb, their bond market guy.  Personally, I think he is completely wrong, but the punditry is consistent in their desperate desire for Warsh to tell them what the Fed is going to do so they can report it and seem smart.

However, my read on the bond market response is quite different, especially when put in context with other markets, notably inflation markets.  The fact that the 2-year yield has backed off, and we have already seen a modest pull-back in the 10-year tells me that there is limited fear of rampant inflation.  While the pundits, and many other central bankers (see Lagarde, Christine) think that hiking rates into an energy price shock is the right move, it has historically been a key policy error.  And what we have learned from financial history is that it is NEVER different this time.  And the folks who trade inflation have breakevens (the difference between nominal Treasury yields and TIPS yields of the same maturity) trading at very ordinary levels of 2.27% in the 10-year and 2.22% in the 30-year.  I thought that Alexandru Stefan Goghiedid an excellent job of describing the situation in his Substack article this morning.

In the meantime, you know who else isn’t really worried about this?  Equity investors.  Broadly speaking, green is today’s color in that asset class, with some of the real movers not even shown in this Bloomberg Screenshot.  

For instance, the KOSPI rallied 17.9% last night after Amazon and Microsoft’s earnings got everybody reconvinced that the AI trade was not over.  This is the market that I had been highlighting as collapsing and it just did a major reversal.  Last night’s candle, on the right-hand side of the chart, is one of the largest you will ever see in a major equity market!

Source: finance.yahoo.com

So, we have made it through the major tech earnings releases and spirits are still high.  While the Fed funds futures markets are still pricing a two-thirds probability of a hike in September and the certainty of one by October, the recent cooler than expected CPI and PCE data will continue to give ammunition to remain on hold.  To me the real question is, will Chairman Warsh be able to convince the committee that reducing the balance sheet is the right thing to do (it is) as that will have a much stronger impact on inflation than raising rates into the energy price shock.

In an aside, lately I have been wondering if every Fed governor should be fired for ‘cause’.  After all, according to legal precedent, cause can mean:

  • Inefficiency – persistent inability or incompetence in performing the role’s administrative or official functions
  • Neglect of duty
  • Malfeasance in office

Now, I would not accuse them of the latter two, but let’s face it, they have completely failed in their official functions as evidence by the fact that even on their own terms of stable prices, it has been more than 5 years since they have achieved their goal.  That seems pretty inefficient or incompetent to me!

Ok, let’s run through the other markets.  Bond yields are higher by 1 tick around the world, and we have discussed them already.  JGB yields, have slipped -2bps, so maybe they are not as worried with the yen strength from yesterday.

Commodity markets are dull with oil (+1.5%) having rallied in the past hour but still hanging around the $85/bbl level with no new news on the war.  At the same time both gold (-1.2%) and silver (-2.0%) are under pressure this morning, although that doesn’t make a huge amount of sense to me given the dollar’s broad weakness.  Perhaps the fact that it is month end is driving flows there, but I am not close enough to those markets to know.

Finally, the dollar is softer, having fallen sharply yesterday although bouncing somewhat this morning.  As you can see in the DXY chart below, we are back within the 96.50/100.50 range that has prevailed for most of the past year and have traded below 100.00 several times yesterday and early this morning.

Source: tradingeconomics.com

To me, this is very interesting as FX traders seem to be taking different signals from the Fed than the short-term interest rate guys.  This does not feel like a market that is anticipating rate hikes in the US.  Now, historically, when it comes to opinion differences across markets, FX traders are the worst of the worst.  And, of course, I am an FX guy at heart, but I have a feeling they are correct here and I still see no rate hikes this year despite the Fed funds futures markets relative certainty.  So, right now, the dollar is broadly firmer by 0.3% across the board with the biggest outlier KRW (-1.35%) seeming to follow the KOSPI.

I think the really important thing to remember here is that the dollar has just not done very much, at least against the G10 currencies, for more than a year.  Certainly, LATAM currencies have performed well this year, but it remains difficult for me to look at the rest of the G10, a group with weak economic activity, and get excited about owning any of them.

On the data front, the PCE data was as expected to softer, but the real key yesterday was the GDP data which showed nominal GDP rose 7.9%, although the inflation adjusted number was just 1.5%.  But this is the very essence of running it hot, high nominal growth, which consisted of significant consumption and investment, while allowing inflation to run as well.  From a debt management perspective for the US, the debt/GDP ratio fell accordingly by about 1%.  While this trend remains higher, I expect we will see more of this type of outcome going forward.

As to today’s releases, Chicago PMI (ep 56.0) and Michigan Sentiment (54.0) are what we see, neither of which seems likely to matter to markets.  The equity bulls are back and that is going to be today’s story.  If those rallies fail, it will portend larger problems I believe, but my take is that is not going to happen.  I guess we shall see.

Good luck and good weekend

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The Die Isn’t Cast

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This morning, investors don’t know
Exactly which way things will go
Unlike in the past
The die isn’t cast
So, some pundits will eat some crow

The question is how will the Fed
Explain how they’re looking ahead?
If Warsh has his way
There’s not much they’ll say
But others, more views, want to spread

As market participants prepare for today’s FOMC statement with the potential for a rate hike, as well as the ensuing press conference, I cannot help but marvel at the recent increase in analysts doing their jobs and being forced to think about what can happen.  This is the healthiest thing about this process I believe.  It is also a very different approach than some current FOMC members have taken as they seem quite dismissive of the process.  For instance, in the WSJ article I cited yesterday, I want to highlight this paragraph;

“Governor Christopher Waller, a former economics professor with a reputation for saying what others won’t, put Warsh on the spot, according to several people familiar with the dinner. What’s the point of all this, he asked. Tell me who you’re putting on these groups, he said, and I’ll tell you what they’ll say. There were no brilliant ideas out there that everyone had somehow missed.”  

This is the very definition of hubris, Governor Waller saying he already has all the ideas and, essentially, the task forces are a waste of time.  Every member of the FOMC and every one of the 300+ or 500+ or however many PhDs who work there are Neo Keynesians and all see the world in exactly the same way.  In fact, they clearly believe that their collective view is the ‘only’ view that is correct.  And yet they have failed at their mission statement for more than 5 straight years.  My take is they are all terribly frightened that other ideas will not only be more effective, but that they will demonstrate all the mistakes the current FOMC has made prior to Chairman Warsh’s appointment.

As of 6:45 this morning, the currently priced probability for a hike, as per the Fed funds futures market, is ~38%, an unusual amount of uncertainty on the day of the meeting.  However, as you can see from the table below, there is virtual certainty of a hike in September and a high probability of one in December as well.  Personally, I disagree they will hike at all this year, but that is what makes markets.

Source: cmegroup.com

It has been two years since there has been this much uncertainty ahead of the meeting, and back then it was a question of 25bps or 50bps as a cut, which I would argue is qualitatively different then determining if there would be any action at all.  Otherwise, you need to go back quite a while to see this type of uncertainty, pre-GFC and the beginning of forward guidance.

Meanwhile, the other story of note is the Iranian attack on a US air base in Jordan and renewed fighting in the Gulf region, more than simply in Iran, which has oil prices rebounding sharply from yesterday’s lows, up 5.0% this morning.  The biggest problem with the oil market, from a market perspective, is that it is all headline risk, whether more attacks, peace talks or some other comment from either President Trump or Iran.  The one thing of which I am certain is that this conflict will not last forever and that when it is over, oil prices will fall back sharply and that over time, the Strait of Hormuz will see its transits decrease to ~5% of the global oil market, making it largely irrelevant to the conversation.

Which takes us to the market activity overnight.  Semiconductor companies continue to have some serious problems as SK Hynix reported earnings last night, which, while they beat expectations, their guidance was weaker than expected.  Given what we have seen from the sector lately, it cannot be a surprise that the KOSPI fell another -6.0% last night.  The chart below shows the relative performance of the KOSPI and NASDAQ over the past 5 years, and I have highlighted the peak.  As you can see, the KOSPI massively outperformed (and we thought the NASDAQ was a bubble!) although it is falling back to earth rapidly.  In fact, YTD, it is only higher by 34.4%, after having nearly doubled at the peak.

Source: Bloomberg.com

Elsewhere in Asia, Taiwan (-3.8%) also suffered as did the Nikkei (-1.5%) although other Japanese indices held up just fine.  China (+0.7%) and HK (+2.0%) had solid sessions and most of the rest of the region performed reasonably well.  Remember, once we get past the Fed today, all eyes will turn to Tokyo for the BOJ meeting which comes Friday.

In Europe, it is a mixed picture with concerns over the rising oil price driving some of the concern as we have also seen yields back up a bit.  Spain’s IBEX (-1.5%) is the laggard, but that appears to be a profit taking situation as the market there had rallied to record highs recently.  Elsewhere, France (-0.5%) is soft while the UK (+0.3%) is picking up slightly after some positive housing news and Consumer Credit activity while the DAX is little changed.  As to US futures, at this hour (7:40) they are edging higher, 0.25% or so.

As I mentioned, yields are backing up this morning with Treasuries (+2bps) outperforming vs. European sovereigns which are all higher by between 3bps and 4bps.  This seems entirely a reaction to the rebound in oil prices as there has not been enough other news to matter.

Metals markets are having another session where the relationship with oil is askew.  Gold is unchanged this morning while silver (+1.0%) has edged higher despite the oil rally.  But these metals remain in a downtrend trading in virtual lockstep as per the chart below.

Source: tradingeconomics.com

Finally, the dollar is mixed this morning, depending on which counterpart you watch.  The DXY (-0.1%) is a touch softer although there has not been much movement at all in the euro, pound or yen.  In the G10, AUD (-0.5%) is the worst performer after inflation data overnight was cooler than expected and the probability of a rate hike fell even further.  NOK (+0.3%) is responding to oil’s rebound and everything else is minimal.  In the EMG, ZAR (-0.5%) is the laggard du jour on the higher oil prices although in fairness, it is holding its own vs. the gold price, having only declined about 2.5% in the past six months despite the sharp, 25% decline in the price of gold.  

You can be sure that after the FOMC today, all eyes will turn to the BOJ and the yen as the next major discussion point for the FX markets.

And that’s really it today.  The only data is the EIA oil inventories with a small draw expected.  And of course, the FOMC this afternoon.  My take is not much will happen ahead of 2:00, but remember, a large portion of the market has their bet wrong as to the outcome, so if nothing else, expect some volatility in the aftermath.

Good luck

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Commit Seppuku

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Alas, nothing’s changed in Iran
And feces is hitting the fan
So, pundits feel strongly, 
Although I think wrongly
A rate hike is part of the plan

In fairness, the bond market, too
Is on board, that ere July’s through
The Fed will have raised
Won’t they be amazed
If Warsh won’t commit seppuku?

Yesterday’s dominant theme was the fact that oil prices had risen so aggressively with WTI above $90/bbl and Brent touching $100/bbl.  Interestingly, both are lower this morning, WTI (-2.5%) and Brent (-2.7%) and both are back below those big psychological levels despite no seeming changes on the ground in Iran.  The Houthis are still causing trouble in the Bab al Mandeb, the US is still attacking sites along the Persian Gulf and there are no peace discussions ongoing.  A headline in the WSJ this morning explained, Trump Is Losing Patience Over an Iran War With No Clear End in Sight.

But really, the bigger discussion has been about US yields (and correspondingly global yields) as they continue to head higher.  Below is a screenshot from Bloomberg showing the yield curve and how yields have changed in the past month and year.

There has been quite a bit of digital ink spilled over the concept that short-dated T-bills have now priced in a rate hike next week, as per Wolfstreet.com,

“The 2-month Treasury yield spiked by 13 basis points today and by 15 basis points during the week to close at 3.95%, according to Treasury Department’s yield calculation. This is at the upper end of the Fed’s target range after it hikes by 25 basis points, which would bring its target range to 3.75%-4.0%. And it is 32 basis points above the Effective Federal Funds Rate (EFFR, blue), which the Fed targets with its policy rates. This is a stunning move, pricing in a “surprise” rate hike at the FOMC meeting next week.”

And here is his accompanying chart.

Of course, what makes all this so juicy is that Chairman Warsh has gone out of his way to end forward guidance so market participants are now left to their own devices to determine what the Fed may do, something most of them have either forgotten, or never knew, how to do.  

Let’s consider, for a moment, some potential outcomes and the rationales behind them.  First, it is critical to remember that Warsh needs a majority of the voters, so at least 7, to get to a result.

  • No change (poet’s estimated probability 90%) – the most recent inflation data, both CPI and PPI were much cooler than expected thus offering significant cover to leave policy on hold.  Add to that the fact that the task forces will not have completed their work and report on anything.  This means Warsh can reasonably say, before we do anything, let’s make sure we are looking at things that are fit for purpose.  One last thing to recall is that if energy prices are the driver, raising interest rates will not produce more energy, so it is the wrong action to solve the problem.
  • 25bp hike (10% probability) – while there have been several FOMC members who discussed the needs for hiking rates as inflation was becoming uncomfortably high, I don’t believe that contingent is large enough to make up a majority, especially of voters.  In addition, the history of central bank rate hikes into energy price spikes is replete with disasters across the board.  After all, the same pundits who are calling for a hike explain that rising energy prices are like a tax and weaken economic activity.  Certainly, the Treasury market price action indicates there are many who believe a hike is coming and if we look at Fed funds futures markets, the probability is higher than mine at about 30% as per the below chart from cmegroup.com, but look at how much that has changed over the past month.  My point is that there is no consistency of view.
  • 50bp hike (NO CHANCE) – there is a group in the analyst community who are calling for a shock maneuver of a 50bp hike.  The rationale seems to be that this would burnish Warsh’s hawkish credentials, and the bond market would rally on the news.  But even if he wanted to do this, and I don’t think that is the case at all, it would require him to get six others to go along.  There is no way that type of viewpoint exists on the committee, I am convinced.  This is clickbait in my view, analysts making outlandish calls so people will read their stuff.

In the meantime, though, yields do continue to rise around the world.  While this morning, they have backed off from yesterday’s recent highs (UST -1bp, bunds -2bps, gilts -4bps, OATs -3bps, BTPs -3bps), they remain just below levels not seen in several years.  One interesting thing about the European sovereign market is the fact that yields in Greece (3.90%) are lower than in either France (3.99%) or Italy (4.01%).  It wasn’t that long ago that Greece was the poster child for fiscal profligacy and lived through a depression.  But give them credit, they learned and now run a primary surplus in their fiscal account, something not seen in many other nations these days, certainly not the US, France or Germany.

But rising rates are wreaking havoc with equity markets, and that has become another fiscal problem since tax receipts from capital gains is such a significant part of the tax base these days, at least in the US.  So, yesterday’s desultory performance in the US, led lower by the NASDAQ’s -2.15% decline, was followed with a similarly negative feeling in Asia (Tokyo -2.7%, China -1.7%, HK -1.0%, Korea -5.7%, Taiwan -2.7%) with the similarity that they are all tech focused.  But weakness in the region was virtually universal, albeit not as dramatic.

In Europe, though, things are looking better after very solid Flash PMI data across the board.  So, Germany (+0.7%) is leading the way higher along with Spain (+0.8%) although France (+0.3%) and the UK (+0.1%) are also in the green, with the latter despite the fact that new PM Burnham is already discussing raising property taxes.  As to US futures, at this hour (7:30) they are marginally higher.  Despite yesterday’s angst, the NASDAQ has not been able to breach the key support level I am watching, as per the below chart.  (If it does, I will be looking to buy QQQ puts, but we shall see if that happens.)

Source: tradingeconomics.com

Briefly regarding metals markets, with oil under pressure today, we cannot be surprised that the metals markets are climbing with gold (+0.2%), silver (+1.2%) and copper (+0.1%) all in the green.  Earlier this week it appeared that relationship may have broken, but it has reasserted itself for now.

Finally, the dollar is little changed this morning, perhaps slightly softer.  But it has rallied over the past week alongside yields as per the below chart of the DXY.

Source: tradingeconomics.com

The major outlier today is KRW (+0.9%) although that is simply an ongoing extension of the central bank’s efforts to add liquidity and internationalize the currency.  Thus far, it has been pretty successful, at least their discussions of the process.  Since things don’t really change until January 2027, I guess we will need to wait until later to find out if it holds up.

But I also wanted to mention the yen (0.0%) which yesterday touched yet another new 40-year low (dollar high).  I have created a chart of USDJPY from FRED data so you can get a sense of how quickly the yen appreciated back then in the wake of the Plaza Accord.  The red circled area down leg took place almost entirely in June 1986.

And that’s pretty much it.  On the data front we get Flash PMIs (exp Manfacutring 54.3, Services 51.5) and New Home Sales (610K).  Once again, we are at a summer weekend so I expect that by noon, things will really slow down.  I don’t believe today’s data will have an impact, and I expect a pretty dull day overall.  Arguably, until the FOMC, absent a major turn in the Gulf, things should remain fairly stagnant as there is no data of note to change opinions. 

Good luck and good weekend

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A Bad Taste

Posted on by 
For weeks, things appeared to get better
As yields slipped and helped every debtor
But we’ve seen some changes
With yields breaking ranges
And oil back to the pacesetter

So, stocks are not really embraced
While bonds have left all a bad taste
The dollar’s moved higher
While gold’s back to dire
With analysts worldwide disgraced

Investors are not as happy this morning as they had been for the past several weeks as the situation in Iran and the Middle East appears to be deteriorating again.  The US continues to attack Iranian missile launchers and fortifications on a daily basis while Iran continues to fire missiles at targets throughout the Gulf region.  As well, the Houthis are back at it in the Red Sea restricting oil flows through there as well.  Arguably the chart below of oil (+4.0%) is the most descriptive view of what is driving everything.

Source: tradingeconomics.com

Crude is higher by 29% in the past month and back above $90/bbl.  This makes things tough on everybody but the oil companies.  Does this mean we are running out of oil?  I don’t think that is the case.  Rather, the short-term impediments to shipping it are driving the price.  But the price is rising nonetheless and that is impacting everything else.  If you recall when things kicked off in this war back in March, the oil price was the primary catalyst for movement in every market. As things seemed to settle down and it appeared there was an opportunity for a resolution, focus turned back to things like earnings for equities and interest rate differentials for currencies with oil in the background.  But it appears we are back to, as oil goes, so goes every other market.

For instance, here is a chart of oil and 10-year Treasury yields over the past month.  As you can see, the trajectory, especially over the past several sessions, is quite similar.

Source: tradingeconomics.com

But if we look at 10-year yields across Europe, we can see that they are all climbing in sync as well.

German yields have reached their highest level in 15 years according to Bloomberg.

The entire moderation story is falling apart.  So, now instead of conversations discussing the relative merits of AI and whether it will be a boon for mankind or end it, we are discussing the probability that the world will end soon.  I guess it’s no surprise that risk is under pressure.  Of course, the latter conversation doesn’t seem that coherent to me as if there is concern over the end of the world, I would have thought gold would have a better bid!

At any rate, oil is the main story and the driver of every market.  It underpins the question of whether the ECB will hike rates today (they won’t) or whether the FOMC will do so next week (also, they won’t) but the probabilities for those moves have risen.  It has also detracted from the earnings stories, or perhaps exacerbated the negatives, or perceived negatives.

For instance, Alphabet reported last night and Q2 revenues beat estimates coming in at $119.8 billion.  But all the talk is of free cash flow, which in this Bloomberg chart shows how much they are spending on the AI buildout.

Here’s my question, is it bad that Alphabet is spending its money to improve its future?  If it recognizes the criticality of AI to the future of its own existence, it seems like a reasonable move.  Of course, the naysayers claim that spending all that cash is a waste.  I don’t know the answer, and I suspect nobody does yet, but companies spending their cash flow on improving their business seems to be the whole idea behind having companies in the first place.  

It begs the question, on what did investors base the value of Alphabet before AI?  If it was seen as only a cash cow, it certainly traded at a very high multiple for a boring business.  But today, it will be tarred with the oil brush along with all stocks.

Ok, I have gone far afield here, let’s get back to markets overnight.  Yesterday’s lackluster US session was followed by strength throughout most of Asia.  Tokyo (+0.5%), China (+0.25%), HK (+1.3%) and Korea (+4.4%) all had solid sessions with Korea continuing to define what volatility means in equity markets.  Look at the expansion in the daily ranges in this barchart.com chart of the KOSPI over the past month.  It’s remarkable!

European bourses, though, are having a much rougher go of things this morning as Brent crude approaches $100/bbl.  France (-1.1%), Italy (-1.9%), Spain (-0.6%) and Germany (-0.6%) are under real pressure this morning as earnings numbers there have been lackluster and the broader macro picture deteriorates all the while.  As to US futures, right now (7:40), they are pointing lower led by the NASDAQ (-1.2%) although it has not yet breached that critical support level as per the below chart.

Source: tradingeconomics.com

We’ve already discussed bond markets, with yields higher this morning by between 2bps and 3bps across Treasuries and all European sovereign markets.  Turning to the metals, while we had a couple of days where they rallied alongside oil, this morning they have reversed course with gold (-1.3%), silver (-2.6%) and copper (-0.7%) all under pressure.  It seems the interest rate story is today’s discussion as higher yields are the topic du jour.

Finally, the dollar is stronger across the board this morning, although most of this strength just materialized over the past few hours with the Asia session broadly unchanged.  But no matter how you slice it, the dollar is firmer vs. all its G10 counterparts by about 0.25% and almost all of its EMG counterparts by a similar amount.  The exceptions this morning are BRL (+0.25%) and KRW (+0.3%).  Regarding Brazil, you must remember they are an oil exporter, so benefit from high oil prices and have amongst the highest real interest rates around, so draw capital for that as well in the carry trade.  The real has appreciated about 8.5% during the past year, so this is nothing new.  As to KRW, the government’s efforts at internationalization continue to be paying off and a look at the chart below shows that this trend is quite strong right now.

Source: tradingeconomics.com

There was an interesting article in Bloomberg this morning explaining how the dollar’s weakness vs. LATAM currencies has begun to bite for local companies but I find it quite interesting when it comes to discussions about the dollar; some find it too strong and are looking for it to tumble while others complain it is too weak!  Seems nobody is ever happy here!

On the data front we see Chicago Fed National Activity (exp 0.14) as well as Initial (212K) and Continuing (1809K) Claims.  Of course, we have the ECB announcement shortly, although no change is expected.  Something getting very little press is the fact that Crude Oil stocks rose in the US last week, but I guess that doesn’t suit the narrative!

This market is entirely focused on oil, and as it moves, so will everything else.  If oil keeps climbing, look for stocks and gold to fall while yields and the dollar rise.  If oil reverses, so with those moves.

Good luck

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Many Critiques

Posted on by 
This evening the president speaks
And pundits have many critiques
Meanwhile in Iran
There’s no clear game plan
As havoc, the president wreaks

But right now, seems traders don’t care
‘Bout Persia or any warfare
Instead, soft inflation
Has changed the narration
So, pundits, high rates now foreswear

Some days, it’s simply more difficult to find stories that bring coherence to the narrative.  But let me try.  Yesterday’s PPI data was also much cooler than forecast, although still clearly quite high on a year over year basis, but it certainly added to Tuesday’s CPI result and has changed a lot of views regarding the Fed’s future actions.  For instance, if we look at my favorite CME table for current probabilities of future rate moves, we see that there is now just a 10% probability of a hike in two weeks’ time, and just one hike priced in for the next 18 months.

Remember, Monday, there was a 40% probability of a hike priced for the July meeting and two+ hikes priced through 2027.  (As I recall, I was an advocate of fading that price action.)  I expect that this will alter the narrative as calls for an immediate rate hike to burnish Warsh’s, and the Fed’s, credibility are likely to fade away.  In the meantime, he didn’t say anything new at the Senate testimony and the rest of the Fed talking heads continue to reiterate that they would be comfortable raising rates if inflation pressures rise.  Remarkably, they didn’t seem to notice the recent numbers.

Turning to the Strait of Hormuz, the US blockade of Iranian vessels is back in force and there have been a significant number of new US attacks on Iranian military sites.  As well, the IRGC has fired drones/missiles at several tankers trying to exit the Strait on the Omani side.  I read this morning that the president is considering whether to escalate things by attacking Kharg or Qeshm Islands, two key Iranian strongholds, and my guess is if that were to be the case, the oil market would likely take a turn higher.  But right now, WTI is effectively unchanged on the day, and has been since Monday’s rise.  I guess $80/bbl +/- is the new home.

Source: tradingeconomics.com

As to the President’s speech tonight, the word is it is going to involve election related issues, seemingly regarding the integrity of elections, the SAVE Act and the results of the 2020 elections.  Recall, Tulsi Gabbard, before she resigned to care for her husband, declassified a great deal of information and some portion apparently was election related.  Alas, this will simply further stoke partisan feelings as there is very little evidence that showing proof of something political has the ability to change the opposing viewpoints of partisans.

So, away from oil, we are now into earnings season, and the big banks all had monster quarters while there is growing angst over the AI sector and whether the main players will be able to make the money that was assumed for so long.  So, while yesterday saw US indices trade higher, the overnight session has been far less positive.

Starting in Asia, Tokyo (-2.8%), China (-1.9%) and Korea (-6.4%) all felt the pain of semiconductor weakness although HK (+1.3%) bucked the trend with most of the rest of the region showing far less movement in either direction.  There was precious little data to drive things, so this clearly seemed to be tech sector woes.  In Europe, broad, but modest, weakness is today’s theme with both France and Germany lower by -0.65% with Spain (-0.5%) also under pressure and the UK (-0.3%) the best of the bunch after GDP data was mildly better than the last reading at 1.3% Y/Y in May.  While the Trade Balance improved a bit, IP was weak and although it has been spun as a positive report, it hardly quickens the pulse.  Meanwhile, at 7:20 this morning, NASDAQ futures are lower by -1.1% although the other two major indices are little changed.  Tech is definitely under pressure here.

In the bond market, this morning we are seeing yields higher by basically 2bps across the board in Treasuries and European sovereigns.  Much is being made of the French OAT 30-year yield this morning as it trades to its highest level since the GFC as per the below from barchart.com.

While this headline of the highest rate in X years is splashy, what we have been seeing consistently, across all nations, is that debt issuance continues to rise and central banks have not been absorbing nearly as much as they had in the more recent past.  This means that the private sector needs to buy bonds, and they are demanding higher yields.  Someone made the point (and I cannot remember where I first read it, but it is valid) that bond yields appear to be less about inflation concerns, per se, and more about the ability for markets to absorb the ever-increasing amount of debt being issued by governments…and companies.  Just look at how much debt is being issued by the hyperscalers to fund their AI buildout.  Regardless of what happens to the front end of the curve and central bank rate activities, it does feel like the back end of the curve is where the signal is going to be found going forward.

Precious metals continue to bat about, rallying and then giving those gains back, but net remain under pressure as gold (-0.75%) and silver (-1.9%) are both softer this morning although copper (+0.7%) continues to find support.  It is difficult to look at the gold chart and be optimistic about a reversal of fortune in the near-term.  

Source: tradingeconomics.com

However, as per the discussion above regarding the increasing issuance of government debt around the world, at some point, the larger fiat vs. physical stores of value question is going to reassert itself and gold will be one of the main beneficiaries of that story.  Alas, it has a history of doing nothing from a price perspective for years on end.

Finally, the dollar, which suffered yesterday, with the DXY slipping -0.5%, is not very interesting this morning.  the pound, interestingly, has slipped -0.3% despite what many are trying to spin as a positive GDP report.  The other noteworthy mover is KRW (+0.4%) on the back of the BOK raising interest rates by 25bps to 2.75% last night.  While this was widely expected, the rhetoric about faster growth driving the need for higher rates has been a boon to the won.  (And remember, this was despite the KOSPI getting crushed last night on weakness in the two big semiconductor firms.)

On the data front, this morning brings the weekly Initial (exp 217K) and Continuing (1820K) Claims as well as Retail Sales (0.2%, -0.1% ex autos) and the Philly Fed (13.0).  With the recent surprises in CPI and PPI, I’m sure there will be a lot of focus on this morning’s Retail Sales data.  Certainly, a weak number will feed into the new, growing narrative, that the economy is slowing and rate hikes are slipping from view.  But yesterday’s Empire Mfg number was quite strong. There are still many inconsistencies in the data, which if nothing else, allows every analyst to point to something and claim they are right.

Ultimately, to me the great concern is an escalation of US activity in Iran, especially bringing troops into play.  In that case, I think things would change a lot, and we could well see another jump in oil prices.  But absent that, right now there is a lot of noise, but not much signal.  I don’t think the big picture has changed, i.e. investment into the US remains strong and that is going to support both the economy and the dollar.  But there will be many twists and turns.

Good luck

Adf

Some Heartburn

Posted on by 
Chairman Warsh, to the House, testified
And explained that his tolerance died
For higher inflation
Throughout this great nation
And ‘bout this, he will not backslide

But prior to his starlike turn
Investors and markets did learn
That CPI fell,
Though not a death knell,
And caused, for rate hawks, some heartburn

It is better to remain silent and be thought a fool than to speak and remove all doubt. – Abraham Lincoln

The attributed saying above, while not certain that it was uttered by President Lincoln, still makes its point eloquently, as well as somewhat humorously.  And I strongly believe that every member of the FOMC should take it to heart before they speak.  In fact, they should be thanking Chairman Warsh for his efforts to shut them up, because then they won’t sound quite so foolish.

For instance, just Monday, Governor Waller, in a speech in New York, finished with the following line, “But I don’t take the inflationary signals I have discussed today lightly. If we get another hot reading on core inflation this week, then the FOMC will need to consider tightening monetary policy in the near term.”  Oops!

And this is one of the issues because many believe that the FOMC gets the data earlier than the release date and so have inside information.  Thus, when Waller talks about the risk of a hot print, many think he knows something.  And this is yet another reason that ending forward guidance and reducing the commentary of the FOMC will be valuable.  

By now, I am sure you are aware that yesterday’s CPI reading was the largest downside miss since Covid in 2020, with the headline number falling -0.4% on the month and the annual slipping back to 3.8% while the core number was flat with the annual falling to 2.6%.  Now, as the Inflation Guy explains, this was the product of numerous subcomponents declining, not just the price of oil/gasoline and this is not the venue to discuss them (read the link).  

But it certainly helped Chairman Warsh in the timing of his testimony as nobody there could ‘blame’ him for still rising prices, at least for now.  As expected, several House members tried to get interest rate information from him, but he remains firm that the Fed’s mission is to drive inflation lower and this will be done through both interest rate and balance sheet policy changes, not through forward guidance.

It is not surprising that the market responded dramatically with the following chart from Polymarket (taken from Kobeissi on X) showing an impressive change of heart.

While I use the Fed funds futures chart from the CME as my guidepost, there is something to be said for the wisdom of crowds here.  Remember, this is a binary call, not a gradient one.  But even the futures markets adjusted significantly, and rightly so, with the probability of a July hike there falling to 16% from 40% when I wrote yesterday morning.  As well, while there is still more than one rate hike priced for 2026, the calculated change has declined to 33bps from 43bps yesterday morning.

Source: cmegroup.com

Skepticism remains rife regarding Chairman Warsh and his attempt to change the way things are done at the Fed, but personally, I am quite optimistic that he is attacking the real problems.  Remember, the Fed is a 114-year-old institution with an extremely long memory and a staff that, like most of government, believes they know what is best for others.  I strongly subscribe to the monetarist view that printing more money leads to more inflation, but making a change that dramatic all at once is just not possible.  Let us be thankful that Chairman Warsh appears to have a better understanding and is working to change things.  And remember, he has only been in the Chair for two months, give him some time.

As I start to recap markets, it is quite interesting that the price of oil seems to have decoupled from the war in Iran.  I say this because as I type at 7:15, a bit more than an hour after CentCom explained they had instituted another wave of military attacks on Iran, WTI is largely indifferent to the news.  While it has edged higher by 0.7%, a look at the chart below of the past 24-hours shows essentially no response.

Source: tradingeconomics.com

So, let’s turn to equities, which rallied on the CPI data in the US yesterday and saw follow through in Asia with Tokyo (+1.5%), HK (+1.4%) and Korea (+6.25%) all having strong sessions as did almost every market in the region.  However, there was an exception, China (-0.2%) which while not disastrous, substantially lagged other markets.  Arguably, the proximate cause of that disappointment was the disappointing data released last night as per the below:

Source: tradingeconomics.com

Certainly, GDP at 4.3%, below even Xi’s reduced target must be concerning and Fixed Asset Investment (housing) continues to crumble.  It is very difficult to look at this data, as well as their monetary data which, for instance, shows loan growth not merely trending lower, but doing so at an accelerating rate as per the below chart and conclude things are going will there for the economy or the equity markets.

Source: tradingeconomics.com

Europe, though, continues to lag with all the major bourses lower as the DAX (-0.8%) leads the way followed by Spain (-0.6%) and then France and the UK both slipping -0.2%. (I guess World Cup results are not indicative of their equity markets!). As to US futures, at this hour (7:25) they are all up very slightly.

Bond yields fell yesterday, notably the 2yr slipping -6bps, while the 10yr only fell -3bps.  This morning, though, yields are edging back higher with Treasury yields up 2bps and European sovereign yields higher by between 3bps and 4bps.  While equity markets remain sanguine about Iran, it seems bond markets are having a tougher time.  JGB yields (-2bps) are bucking the trend as there are still those who are looking for Japanese pension funds to start bringing more money home.

While the metals markets rallied yesterday, this morning they are under pressure again with gold (-0.6%) and silver (-1.2%) giving back yesterday’s gains while copper (-0.3%) is consolidating after jumping a dime yesterday.

Finally, the dollar is sidelined this morning with no notably large movements in either the G10 or EMG blocs.  A brief word on the yen, which has certainly been the subject of much digital ink spillage lately, as it seems all those thoughts of the pension fund support for the yen are not part of the FX conversation.  We remain less than 50 pips from the peak seen back on June 30 and I see very little reason for the broader trajectory to change.  The BOJ is not going to waste its reserves in this process, and given the gradual movement, I don’t think they are that upset.  As long as PM Takaichi is planning to spend more money, whether on infrastructure or investment, given they are borrowing all of it, a strong yen seems highly improbable.

On the data front, this morning brings PPI (exp 6.2% headline, 5.2% core) and the Empire State Manufacturing Index (8.8) at 8:30.  Then, at 9:45 the BOC will most likely leave their base rate on hold at 2.25% and at 10:00, Chairman Warsh will testify to the Senate Banking Committee.  We also get the Fed’s Beige Book this afternoon, EIA oil inventories and three more Fed speakers, although with Warsh speaking, will anybody care?  Especially since they continue to make fools of themselves with their own forward guidance.

The most remarkable thing to me is how insouciant market participants have become despite increased hostilities in the Gulf.  But both oil and equity traders have seemingly decided that other things matter more.  With that in mind, it is hard to get excited about too much these days.  Unless we see markets breaking their recent ranges, in either direction, I suspect that the weight of summer, and reduced liquidity is going to prevent anything substantial from happening anytime soon.

Good luck

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The Score

Posted on by 
Hormuz is blockaded once more
The latest response in the war
So, crude prices rose
While both sides expose
Their relative views of the score

Now after a month of some peace
Seems tensions are set to increase
So, what about stocks?
The sales are in blocks
While buyers, few bids will release

After a brief respite for markets, where oil had seemed to be drifting out of the headlines, the events of the past weekend plus the US reimposition of the blockade of the Strait of Hormuz has changed the narrative dramatically, and rightly so.  The benign attitude of an eventual conclusion to this situation has been tossed aside and the oil bulls and war hawks are both back in the ascendancy.  Yesterday ultimately saw oil prices rise 9.4% and this morning they are a further 3.2% higher, and perhaps more importantly, back above the psychological level of $80/bbl.

Source: tradingeconomics.com

There doesn’t seem to be any short-term solution to this situation.  There are clearly enough hard-liners still with power in Iran to prevent any move toward a negotiated solution.  As long as this maintains, the outlook for oil will tilt higher.  However, as I have written before, and is very clear now, the effort to reroute oil shipments from the Gulf nations away from the Strait is intensifying and will continue to do so.  As well, alternative sources of supply including additional US production, Brazil, Argentina, Guyana, Venezuela and Canada are satisfying demand.  While uncertainty remains high, especially in the short run, by the end of next year, my take is less than 8% – 10% of the world’s oil will need to transit the Strait.  However, in the meantime, given that everybody who was long oil as the war initially ramped up has sold out, there are few sellers left to cap the price.  I imagine a move toward $90/bbl is quite possible in the next weeks.

As well as the story on crude
Two other themes will be pursued
First CPI’s print
Will offer a hint
Then Warsh will discuss why he’s screwed

If we turn our attention away from the oil market now, the two main events today are the CPI release at 8:30 this morning followed by Chairman Warsh testifying to the House Financial Services committee in his semi-annual trip to Congress.  Starting with CPI, expectations are for a decline from last month as headline (exp -0.1% M/M, 3.8% Y/Y) and core (0.2% M/M, 2.8% Y/Y) are due.  From what I can tell, there are a number of analysts who are calling for a relatively hotter number, although I’m not sure on what basis they believe that.  Certainly, oil prices, and energy prices across the board, declined significantly in June and that will be reflected in the reading.  Looking at the home price data, that doesn’t appear to have risen dramatically, and other commodity prices have also slipped.  I don’t’ rule out any outcome, but on the surface, expectations seem reasonable.  

Of course, with oil prices rising, talk of more rate hikes is all the rage and according to the Fed funds futures market, as per the below CME table, you can see that expectations have risen to a 40% probability of a hike this month and a two-thirds probability of two hikes before the end of the year.  My personal view, FWIW, remains that there will be no hikes this year, although with the resumption of hostilities in the Gulf, I think a cut is off the table as well.  Remember, too, that if oil prices remain elevated that will negatively impact economic activity, so hiking rates into that scenario doesn’t seem to make much sense.  But then, I’m not on the FOMC.

Now, I have long maintained that FOMC members should shut up, but it seems Mr Warsh will have a hard time getting them to do so.  I’m not sure if they think they are helping, or they are just enamored with their own voices.  But yesterday, Governor Waller spoke and explained that if the CPI data was hot, a rate hike would be an appropriate response.  And remember, we hear from another 7 or 8 of these folks just this week, four today!  

While I expect that Warsh’s testimony will be dry, and that most of the questioning will be either long-winded preening by some idiot member, or an attempt at a gotcha question, I am confident that Chairman Warsh will continue to avoid discussing his views of where policy should go and reiterate forcefully that the Fed’s goal is to reduce inflation, full stop.  I am also confident that he will not be dragged into any discussions of other issues like global warming or DEI and simply repeat that ending inflation is the only job he has.  We shall all find out shortly.

On to the markets.  It should be no surprise that equity markets were under pressure yesterday in the US with the jump in oil prices.  This added to the chorus of those who believe the AI bubble is popping as the NASDAQ led the way lower, falling -1.5%.  But a funny thing happened in Asia.  Despite the jump in oil prices and declines in US equity markets, Tokyo (+0.75%), HK (+0.5%) and China (+2.15%) all rallied nicely last night.  In fact, so did Korea (+0.7%) and Malaysia (+1.3%) although we did see declines in India (-0.7%) and Taiwan (-1.4%) with the rest of the region moving far less.  This is a surprising outcome to me, especially as Asia is the region most negatively impacted by rising oil prices.

Europe though is trading true to form with declines across the board ranging from Spain (-1.1%) to the UK (-0.4%) and everywhere in between.  There has been precious little data overnight to drive things, and this appears to be entirely oil related.  Of course, Europe’s suicidal energy policy, notably the UK’s ban on drilling for oil in the North Sea, remains one of the key reasons that the area will continue to struggle.  As to US futures, this morning DJIA futures are lower (-0.8%) but the other two major markets are little changed at this hour (7:25).

In the bond market, 10-year Treasury yields jumped 6bps yesterday although are little changed this morning.  However, as you can see from the chart below, they are pushing back up toward the highs seen in late May.

Source: tradingeconomics.com

There is a lot of talk about how Warsh should hike rates aggressively this month to gain bond market credibility in his fight against inflation, but I sense that is a lot of people talking their books.  I continue to believe that there will be no Fed action ahead of task force reports.  As to other nations, yields are generally firmer in Europe today, ranging between +1bp (Germany) and +3bps (Italy) with the UK worst of all (+4bps) as 10-year Gilts now yield more than 5.0% again, also pushing back to late-May highs.  The one exception is Japan (JGBs -5bps) where the latest ploy by Katayama-san is to propose JGBs be allowed to be invested in tax-free accounts for individuals in Japan.  Given the long history of zero rates there, a tax-free return of 2.7% with no currency risk could well be quite attractive, I think.

In the metals markets, it is no surprise that both gold and silver fell yesterday with the jump in oil prices, but despite oil’s continued rally this morning, both gold (+0.7%) and silver (+0.7%) are finding support, with gold seeming to hold the $4000/oz level for now.  Copper (+1.6%) is also holding up well, but its relation to the precious sector seems to be waning.  Perhaps the precious metals story is less about oil and more about the dollar.

Turning to the dollar, yesterday it put in a strong performance with the DXY rallying about 0.3% from Friday’s closing levels as you can see in the chart below.

Source: tradingeconomics.com

However, as you can also see in the chart, this morning the greenback is under pressure despite the rise in oil prices and yesterday’s increase in yields.  The biggest outlier is NZD (+0.9%) as the RBNZ continues to make hawkish statements about the need for further rate hikes.  And of course, NOK (+0.7%) is benefitting from the oil price rise.  But the rest of the G10 are all firmer, and so is most of the EMG bloc with only INR (-0.5%) standing out as underperforming.  That story appears to be based on higher oil prices and concerns, or thoughts at least, that the RBI will not be aggressively hiking rates to protect the rupee.  Otherwise, most currencies have moved higher vs. the dollar on the order of +0.15% to +0.25%.

And that’s really it today with CPI the only data release other than the already released NFIB Small Business Optimism index (97.4, exp 95.8), but that predates the change in the Gulf.  Chairman Warsh has his work cut out for him to get his colleagues to shut up.  I wonder if he can fine them if they speak.

We are in a narrative transition right now, but longer term, I remain bullish the US and the dollar.  

Good luck

Adf

Much Hotter

Posted on by 
This weekend both wars got much hotter
Iran attacked ships on the water
Ukraine sent its drones
Across three time zones
And struck inside Vlad’s magna mater

Thus, oil has risen a bit
While gold and stocks both trade like sh*t
And soon, CPI
Will prove or deny
That views at the Fed are now split

By now, of course, you know that there has been more military activity in the Strait of Hormuz with the IRGC attacking commercial ships and the US retaliating with significant strikes of military sites along the Strait.  From what I can see, there are factions within the IRGC that do not want to end the conflict and whatever government exists within Iran has no control over them.  As such, it is no surprise that the price of oil (+3.5%) has risen, but even in this scenario, it is well off its overnight highs.

Source: tradingeconomics.com

At this point, I believe the trading community will need far greater proof that there is a shortage of oil before responding with significantly higher prices.  Of course, one way that could come about is if Ukraine continues its success with attacks on Russian oil infrastructure as there has been an uptick in that activity with several refineries having been hit in the past several days and Russia imposing an export ban on diesel.  Net, things in the oil space remain precarious, but for all the analysts who continue to promulgate the idea that the end is nigh, markets continue to disagree.  As always, I vote with markets here.

And, not surprisingly, other markets have responded in a similar fashion to their recent trends with higher oil prices leading to pressure on both stocks and bonds, as well as precious metals while the dollar finds some support.  The thing is, my take is the strength of these correlations has been waning somewhat.  Frankly, and remarkably, it appears as though an increase in military activity in the Strait of Hormuz has become somewhat normalized to traders and they are looking for other, fresher signals as to their next move.

What might those other signals be?  Well, much was made of SK Hynix’s IPO in the US on Friday, which many pundits are now calling the top as the stock fell sharply in Korea overnight, down -15.4% dragging the KOSPI down -9.0% and tech stocks, in general much lower.  Of course, the KOSPI had risen dramatically over the past year, as you can see below, and is still higher by more than 100%  in the past year despite the recent decline of more than 25% since its peak on June 22.

Source: finance.yahoo.com

The problem with calling the top in stocks is that the earnings data, which starts in earnest this week, has been pretty good so far.  If companies continue to earn real profits, investors will continue to purchase stocks.

So, where else can we turn for new information?  Tomorrow brings the latest CPI report (exp 3.8% headline, 2.9% core), and you know that will be heavily scrutinized as the punditry tries to determine the FOMC’s reaction function and if it has changed with the new Chairman.  At this point, I do believe the Fed’s reaction function has changed, and more importantly, I don’t think anybody knows what it will be like, the Fed included.  The previous Fed whisperer, Nick Timiraos at the WSJ put out an article overnight discussing the idea that Chairman Warsh needs to decide whether to undo the most recent rate cuts.  However, there is no evidence that Warsh speaks to Timiraos and based on everything Warsh has said, he is not likely to tip his hand.  Chairman Warsh does testify to Congress this week, but I expect he will deflect all questions about the future path of monetary policy, and let’s face it, with the likes of Maxine Waters on the House committee, they won’t understand anything he says anyway.

And really, those are the only things that I think matter for now, so let’s review the overnight activity in markets.  As mentioned above, stocks are generally under pressure, but not universally so.  For instance, in Asia, Tokyo (-1.9%), China (-1.8%) and the aforementioned South Korea all had rough sessions, but HK, Taiwan, India and Australia were all basically flat on the day.  The big surprise is Taiwan as given the semiconductor weakness; I would have thought that market would have been significantly impacted.  But I guess not.  Meanwhile, European investors appear to be completely focused on tomorrow’s France-Spain World Cup semifinal as equity indices there are virtually unchanged this morning.  As to US futures, at this hour (7:30) NASDAQ futures are weaker by -1.2%, but the other markets are little changed.

Bond yields are higher this morning, but not hugely so.  Treasury yields have edged up by 1bp, and European sovereign yields are higher by 2bps across the board with UK Gilts (+4bps) the real laggard there.  Overnight, JGB yields backed up 4bps as well, but that story has more to do with the GPIF than anything else.

Remember Friday?
Japan was bringing home yen
They were just kidding

Think back to Friday.  Japanese FinMin Katayama mentioned that the GPIF and other Japanese pension funds ought to consider investing more money in Japan and less abroad.  That got tongues wagging about a major policy change coming that would serve to support the yen, and the JGB market while undermining Treasuries as the idea was the GPIF would sell their US Treasuries and buy JGBs instead.  Well, it turns out that is not actually the case.  The GPIF reevaluates its policy annually but has expressed no urgency to change things now despite the FinMin’s comments, at least according to Reuters.  The upshot is that JGBs sold off as did the yen (-0.3%) as per the below chart.

Source: tradingeconomics.com

Perhaps more surprisingly, though, the dollar is mixed on the day, not higher across the board as might have been expected given the uptick in oil and military activity.  So, we have seen weakness in GBP (-0.1%), AUD (-0.2%) and INR (-0.5%) while EUR (+0.1%), NZD (+0.2%), NOK (+0.3%) and KRW (+0.4%) have all had decent sessions.  Net, the DXY is essentially unchanged this morning.

Finally, and quickly, both gold (-1.5%) and silver (-2.0%) are under pressure with the higher oil price although copper (+0.6%) continues to find support and remains well above $6.00/lb.

In addition to the CPI data, it is a pretty busy week as follows:

TuesdayNFIB Small Biz Optimism95.6
 CPI-0.1% (3.8% y/Y)
 -ex food & energy0.2% (2.9% Y/Y)
 Warsh Testimony 
WednesdayPPI-0.1% (6.2% Y/Y)
 -ex food & energy0.3% (5.2% Y/Y)
 Empire State Mfg8.9
 Warsh Testimony 
 Fed’s Beige Book 
ThursdayInitial Claims218K
 Continuing Claims1811K
 Retail Sales0.2%
 -ex Autos-0.1%
 Philly Fed13.5
FridayHousing Starts1.30M
 Building Permits1.40M
 IP0.2%
 Capacity Utilization76.2%
 Michigan Sentiment51.5

Source: tradingeconomics.com

We also hear from 9 other Fed speakers (it almost seems like they didn’t get the memo about reducing communication) but with Warsh on the stand both Tuesday and Wednesday, I don’t think the others will matter that much.  Of course, it will be interesting to hear the other speeches if CPI comes in softer than expected as it may put a crimp in the hawks’ views.

In the end, not that much has really changed I would argue.  The war is an exogenous variable, and the market has learned to largely ignore it.  The Fed is still too uncertain in its new construction for many views to have changed, but I think the one thing we can conclude is that the old models of their reaction function are no longer viable.  My take is the beauty of the task forces for Chairman Warsh is they won’t report for at least 3 months, and probably more like 6 months, so until they report, absent a massive spike in measured inflation, the Fed is not going to do anything.  The Fed funds futures market is now pricing a one-third probability of a hike at the end of this month and certainty of one and 50% probability of two by the end of the year.  I would fade those trades.

Good luck

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Young Turks? Or Warhorses?

Posted on by 
Stories about yen
Have multiplied like rabbits
Is it really news?

You know it has been a slow session when the yen’s movement, as seen in the chart below, was enough to draw 4 headline stories in Bloomberg.

Source: tradingeconomics.com

And here is a screenshot of the 4 headlines on Bloomberg.com

While it may look dramatic on the screen, that almost one yen move represents less than 0.6%, and as you can see, about half of it has already retraced.  The underlying premise is that FinMin Katayama, in a regular speech about general things, suggested that the GPIF (Japan’s national pension fund) ought to consider investing more assets in Japan and JGBs rather than internationally.  The idea is that if the GPIF changes its investment mix, so will many other Japanese institutional funds, and they do have a lot of money there, upwards of $2 trillion equivalent.  This is not to say that they are going to invest all their money back home, just that the mix could change somewhat.

Now, if they were to do this, it would certainly have an impact on both the FX and global bond markets, with the yen likely to strengthen along with JGB prices (hence JGB yields declining) and potentially Treasury yields rising as a key buyer of US debt would reduce its appetite.  

But this is just a suggestion, and one that has been made numerous times in the past with no further action.  At the same time, yesterday’s US 30-year Treasury auction was extremely well-received with more than 77% indirect bidders.  That statistic is generally seen as foreign investors and central banks.  With the yield coming at 5.058%, it is not surprising that foreign bidders, especially the Japanese, would have significant interest.  After all, their currency continues under pressure, so if the GPIF holds Treasuries, in yen terms they look better almost every day.

The other spate of stories this morning was about the carry trade, and how Goldman Sachs has just explained to its clients that the carry trade, notably shorting yen to hold dollars, amongst other things, is an excellent risk reward trade right now.  I’m guessing Katayama-san didn’t really want to hear that.

My larger point, though, is that despite the yen (+0.4%) having moved a relatively modest amount, it certainly garnered a lot of attention.  In other words, there’s not much else to discuss.

Since Warsh and his minions last met
The question was who they would vet
To lead the task forces
Young Turks? Or warhorses?
Alas, tis the latter quintet

The other moment of excitement yesterday came from the Fed when they released the names of the leaders of each of Chairman Warsh’s five task forces.  The list is linked here.  It certainly did engender a lot of discussion with different analysts taking different views, and while I have some opinions, mine are no more useful than anybody else’s as they are not going to change things.  My observation, though, is that there is an awful lot of old school thinking represented by the list, which is somewhat disappointing for those of us who were looking for a new direction from the Fed.  As an example, Mervyn King, ex-BOE governor, and active participant in forward guidance, seems unlikely to offer many new views on communications.  But that is what we have.  Hopefully some new thinking will come about.

And that’s all there is regarding news, I think so let’s turn to market activity.  Under the theme, you can’t keep tech stocks down, yesterday’s US equity rally was followed by more strength (Tokyo +1.2%, HK +0.6%, Korea +2.5%, India +1.1% and Australia +0.5%) than weakness (China -2.0%, Taiwan -0.8%) in Asia.  The rest of the smaller regional exchanges were largely higher as well.  Arguably, the fact that whatever is happening in the Strait of Hormuz, oil prices have no strong bid, is part of that investment thesis.  As to Europe, other than Spain (+0.5%), the rest of the continent and the UK are all +/-0.1%.  And US futures at this hour (7:15) are showing softness in the NASDAQ (-0.5%) but otherwise not much movement.

Bond yields, though, are uniformly lower, backing off their recent test of 4.60% in 10-year Treasuries, as now that the auctions have passed, I think a lot of the short positioning into those auctions has been covered.  If oil continues to trade either side of $70/bbl, it is hard to make the case inflation will be running away.  So, Treasuries (-2bps) continue to back off while European sovereign yields have slipped by a similar amount.  The outlier was the JGB market (-13bps) which as you can see in the below chart has really changed vs. its following of Treasury yields, entirely on the GPIF story.

Source: tradingeconomics.com

In the commodity space, oil (+0.3%) continues to erase the gains seen Tuesday after the increase in military activity in the Strait.  Even though that seems to be ongoing, the markets just don’t care.

Source: tradingeconomics.com

As to the metals, yesterday’s gains are being moderated with both gold (-0.4%) and silver (-0.7%) slightly softer while copper is unchanged on the day.

Finally, the FX market, away from the yen, remains generally uninteresting.  Three weeks ago, much was made of the DXY’s break higher from a longer-term range as it traded through 100.50, almost reaching 102.00.  but as you can see in the chart below, for now, that excitement seems to be fading with a nice little downtrend developing since June 24th.

Source: tradingeconomics.com

In these dog days of summer, it is hard to get too excited.  Generically, while I remain in the camp that the Fed will not adjust rates this year, and so the market will need to reduce the current 33bps of rate hikes priced into the Fed funds futures curve as you can see below, I also think that ongoing inward investment into the US is going to underpin the dollar over the medium term.

There is no data to be released today, and yesterday’s numbers saw a marginally better Initial Claims number (215K vs 218K expected) and a slightly worse than forecast Existing Home Sales number.  As well, we heard from NY Fed president Williams who said his new main concern is that demand for AI infrastructure is going to drive inflation higher and he is wary of that.  Of course, that is exactly at odds with Chairman Warsh’s view that AI is going to reduce inflationary pressures.  Next week, Chairman Warsh will be testifying to Congress and there are four other Fed speakers, but my take is that over time, we will hear less and less from the rest of the Committee. (Or maybe that is just wishful thinking on my part!)

At any rate, it is shaping up to be a quiet one, so close up early and take a long weekend, you’ve earned it!

Good luck and good weekend

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