Tag Archives: interest-rates

Not in a Hurry

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Said Jay, we are not in a hurry
To cut, as the future is blurry
As well, since it’s Trump
We don’t want a slump
‘Cause really, his favor, we curry

 

Apparently, the Chairman is reading FX Poetry (🤣) these days as he has come to the same conclusions I have drawn, there is no reason to cut rates anytime soon.  Yesterday, in a moderated discussion in Dallas, the Chairman said, “The economy is not sending any signals that we need to be in a hurry to lower rates. The strength we are currently seeing in the economy gives us the ability to approach our decisions carefully.”  And let’s face it, yesterday’s data simply added to the picture where the employment situation is not in trouble (Initial Claims rose only 217K, less than expected) while inflation signals remain hotter than desired with both core CPI and core PPI looking like they have bottomed as per the chart below.

Source: tradingeconomics.com

One of the things that Fed speakers consistently discuss is whether or not current policy is accommodative or restrictive based on their view of where the neutral rate of interest lies.  The problem, of course, is that neutral rate, also known as R* (R-star) is unknown and unknowable, only able to be determined in hindsight.  But that doesn’t stop them from trying.

At any rate, a consistent theme we have heard recently from Fed speakers is that they believe their policy is restrictive, hence the need to lower interest rates at all.  But there is a case to be made that policy is not restrictive at all right now as evidenced by the fact that the 10-year Treasury rate is actually below the “true” risk free rate.  How is that possible you may ask.

Consider that 30-year mortgage rates are also generally considered risk-free as not only are they collateralized, but they are mostly guaranteed by FNMA, GNMA and FHLMC, quasi government agencies that were shown to have the full faith and credit of the US government behind them when things got tough during the GFC.  Historically, meaning prior to Covid, the spread between 30-year mortgage rates and 10-year Treasuries was about 165bps on average.  However, since February of 2020, that average spread has expanded to 230bps.  (Notice how the green line representing the difference between the two rates is stably higher since Covid in 2020.)

Source: data FRED database, calculations @fx_poet

That difference is important because if you consider the idea that mortgage rates represent a better estimate of the “true” risk-free rate, then Treasury yields are cheap by 65bps relative to where they would otherwise be.  In other words, policy is looser by that amount than the Fed believes.  Why would this be the case?  Well, QE has very obviously distorted the price signals from the bond market.  Now, I grant that the Fed has also distorted the mortgage market (recall, they still own $2.26 trillion of those), but despite the ongoing QT process, they own $4.3 trillion of Treasuries.  And if price signals are distorted, making policy becomes that much tougher for the Fed.  It seems quite possible that through their own actions they have lost sight of reality and therefore, continue to make policy based on inaccurate data.  I would offer that as an explanation as to why the Fed always seems out of touch…because they are looking at the wrong things.

Ok, let’s take a look elsewhere in the non-political world to see what is going on.  Last night, China released their monthly data on Retail Sales (4.8% Y/Y), IP (5.3% Y/Y), Unemployment (5.0%) and Fixed Asset Investment (3.4% Y/Y).  Some parts were good (Unemployment was a tick lower than last month and expected, Retail Sales was a full point higher than expected) and some not so good (IP was 0.3% lower than forecast and Fixed Asset Investment came in 1 tick lower.). As well, the House Price Index there fell -5.9% Y/Y last month, which as you can see in the chart below, is indicative of the fact that the property problems in China are still significant and seemingly getting worse.

Source: tradingeconomics.com

However, one thing China is doing is pumping up its exports ahead of the inauguration of Donald Trump as they are clearly very concerned over the widely mooted 60% tariffs to be imposed on Chinese exports to the US.  In October, exports exploded higher by 12.7% and I expect we will see that again in November and December as companies there do all they can to beat the clock.  One thing this will do is help goose GDP data in China so that 5.0% growth target seems much more attainable now.  How things play out going forward remains to be seen, but for now, China is going to push as hard as possible.

Alas for the Chinese, that data and this idea did nothing to help the stock market there where the CSI 300 fell -1.75% last night, the laggard in the Asian time zone.  Given equities are discounting instruments, it appears people are more concerned over the future than the past.  Elsewhere in Asia, markets were generally flat to modestly firmer (Nikkei +0.3%) after (despite?) the US equity declines yesterday.  In Europe this morning, most markets are little changed to slightly softer  although Spain’s IBEX (+0.9%) is bucking the trend with its financial sector performing well, perhaps on the idea that the two big Spanish banks, Santander and BBVA, will benefit from the Fed’s seeming policy shift.  However, US futures are softer at this hour (7:15) lower by between -0.3% and -0.6%.

In the bond market, yields around the world are virtually unchanged this morning with 10yr Treasuries at 4.43% and no movement in either Europe or Japan.  This feels to me like investors are not sure which way to go.  Perhaps more are beginning to understand my type of explanation above regarding where things are now and are unsure how to play the future regarding inflation prospects, especially with potentially large changes coming under a new administration.  My take is yields will continue to drift higher alongside rising inflation, but that is not a universal view at all.

In the commodity space, oil (-0.4%) is a touch softer this morning although the big declines seemed to have stopped for now.  Here, too, uncertainty about how policy will evolve going forward has traders on the sidelines. In the metals markets, yesterday’s lows seem to be holding for now as while gold is unchanged on the session, both silver (+0.85%) and copper (+1.75%) seem to be rebounding.  If yields are going to continue higher, the road for metals is likely to be tough, but ultimately, lack of supply is going to drive this story.

Finally, the dollar is giving back some of its gains from this week in what appears to be a profit taking move.  It can be no surprise this is the case, especially given holding positions over the weekend at the current time remains a fraught exercise.  After all, will there be an escalation in Israel/Lebanon?  Ukraine?  Somewhere else?  And what will Trump announce over the weekend?  There has still been no announcement regarding his Treasury Secretary, and that is obviously crucial.  So, the dollar has given back about 0.3% of this week’s move largely across the board and I wouldn’t give it any more thought than that.

On the data front, this morning brings the Empire State Manufacturing Index (exp -0.7) as well as Retail Sales (0.3%, 0.3% ex autos) at 8:30.  Then, at 9:15 we see IP (-0.3%) and Capacity Utilization (77.2%).  There are no other Fed speakers scheduled today, although after Powell pushed back on further rate cuts yesterday, it will be interesting to hear the next ones and how they describe things.  If today’s data is hot, I would expect the probability of a rate cut in December, which currently sits at 62.4%, to fall below 50%.  As I have maintained, there just doesn’t seem to be much of a case to keep cutting given the economy’s overall strength.

With that in mind and given that growth elsewhere in the world is lagging, I still like the dollar to maintain and gain strength going forward.

Good luck and good weekend

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Right On Humming

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So, CPI didn’t decline
And may not be quite so benign
As Jay and the Fed
Consistently said
When hinting more rate cuts are fine
 
However, that will not deter
Chair Powell, next month, to confer
Another rate cut
Though it is somewhat
Unclear if his colleagues concur

 

Despite the fact the narrative is pushing Unemployment as the primary focus of the FOMC, yesterday’s CPI report, which seemingly refuses to decline to the Fed’s preferred levels, had Fed speakers beginning to hedge their bets regarding just how quickly rates would be coming down from here. [Emphasis added.]

St. Louis Fed President Alberto Musalem explained, “The strength of the economy is likely to provide the space for there to be a gradual easing of policy with little urgency to try and find where the neutral rate may be.”

Dallas Fed President Lorrie Logan commented (using a series of maritime metaphors for some reason) “After a voyage through rough waters, we’re in sight of the shore: the FOMC’s Congressionally mandated goals of maximum employment and stable prices, but we haven’t tied up yet, and risks remain that could push us back out to sea or slam the economy into the dock too hard.”  

Finally, Kansas City Fed President Jeff Schmid told us, “While now is the time to begin dialing back the restrictiveness of monetary policy, it remains to be seen how much further interest rates will decline or where they might eventually settle.”  

If we ignore the oddity of the maritime metaphor, my takeaway is that the Fed is still looking to cut rates further as directed by Chairman Powell, but the speed with which they will act seems to be slowing down.  As I have maintained in the past, given the current data readings, it still doesn’t make that much sense to me that they are cutting rates at all, but arguably, that’s just another reason I am not a member of the FOMC.  Certainly, the market is on board as futures pricing increased the probability of that cut from 62% before the release to 82% this morning.  There is still a long way to go before the next meeting, with another NFP, PCE and CPI report each to be released, as well as updates on GDP and Retail Sales and all the monthly figures, so this story is subject to change.  But for now, a rate cut seems likely.

One other thing, I couldn’t help but notice a headline that may pour a little sand into the gears of the rate cutting apparatus at the Eccles Building.  This is on Bloomberg this morning: Manhattan Apartment Rents Rise to Highest Level Since July.  Again, the desperation to cut rates seems misplaced.

Despite the fact rate cuts are coming
The dollar just keeps right on humming
This morning it’s rising
Which ain’t that surprising
As more depths, the euro is plumbing

Turning our attention to the continent, European GDP figures were released this morning, and they remain disheartening, to say the least.  While the quarterly number rose to 0.4%, as you can see from the chart below, it has been several years since the continent showed any real growth, and that was really just the rebound from the Covid lockdowns.  Prior to Covid, growth was still lackluster.

Source: tradingeconomics.com

While these are the quarterly numbers, when looking at the Y/Y results, real GDP grew less than 1% in Q3 for the past 6 quarters and, in truth, shows little sign of improving.  After all, virtually every nation in the Eurozone is keen to continue their economic suicide via energy policy and regulation.  This thread on X (formerly Twitter)is a worthwhile read to get an understanding of the situation on the continent.  I show it because this morning, the euro has fallen yet further, and is touching the 1.05 level, seemingly on its way to parity and below.  It highlights that since just before the GFC, the Eurozone economy has fallen from virtually the same size as the US economy, to just 60% as large, and explains the key reasons.  Read it and you will be hard-pressed to consider the euro as a safe store of value, at least relative to the dollar.  And remember, the dollar has its own issues, but at least the US economy remains dynamic.

But the dollar is king, again, this morning, rising against virtually all its counterparts on the session.  Versus the G10, the average movement is on the order of 0.3% or so, but it is uniform.  USDJPY is now pushing 156.00, the pound seems headed for 1.2600 and Aussie is below 0.65.  My point is concerns about the dollar and its status in the world seem misplaced in the current environment.  If we look at the EMG bloc, the dollar is stronger nearly across the board as well, with similar gains as the G10.  MXN (-0.5%), ZAR (-0.4%) and CNY (-0.2%) describe the situation which has been a steady climb of the greenback since at least the Fed rate cut, and for many of these currencies, for the past 6 months.  Nothing about President-elect Trump’s expected policies seems likely to change this status for now.

If we look at equity markets, yesterday’s US outcomes were essentially little changed on the day.  However, when Asia opened, with the dollar soaring, we saw a lot more weakness than strength, notably in China with the CSI 300 (-1.7%) and Hang Seng (-2.0%) leading the way lower although the Nikkei (-0.5%) also lagged along with most other Asian markets.  While there were some modest gainers (Australia +0.4%, Singapore +0.5%) red was the predominant color on screens.  In Europe, however, investors are scooping up shares with the DAX (+1.2%) leading the way although all the major bourses are higher on the session.  It seems that there is a growing consensus that the ECB is going to cut 25bps in December and then another 25bps in January, which has some folks excited.  US futures, meanwhile, are slightly firmer at this hour (7:00).

All this is happening against a backdrop of a continued climb in yields around the world.  Yesterday, again, yields rose with 10yr Treasuries trading as high as 4.48%, their highest level since May, and that helped drag most European yields higher as well.  This morning, we are seeing some consolidation with Treasury yields backing off 1bp and European sovereign yields lower by -2bps across the board.  The one place not following is Japan, where JGB yields edged higher by 1bp and now sit at 1.05%.    Consider, though, that despite those rising yields, the yen continues to slide.  In fact, that is the correlation that exists, weaker JPY alongside higher JGB yields as you can see in the below chart.

Source: tradingeconomics.com

While it is open to question which leads and which follows, my money is on Japanese investors searching for higher yields, selling JGB’s and buying dollars to buy Treasuries.

Finally, the commodity space continues to get blitzed, or at least the metals markets continue that way as once again both precious and industrial metals are all lower this morning.  In fact, in the past week, gold (-5.7%), silver (-6.4%) and copper (-9.1%) have all retraced a substantial portion of their YTD gains.  It is unclear to me whether this is a lot of latecomers to the trade getting stopped out or a fundamental change in thinking.  My view is it is the former, as if the Trump administration is able to support growth, I expect that will reveal the potential shortages that exist in the metals space.  Oil (+0.4%) is a different story as it continues to consolidate, but here I think the odds are we see lower prices going forward as more US drilling brings supply onto the market.

On the data front, this morning brings the weekly Initial (exp 223K) and Continuing (1880K) Claims data along with PPI (0.2%, 2.3% Y/Y) and core PPI (0.3%, 3.0% Y/Y).  In addition, the weekly EIA oil data is released with modest inventory builds expected and then we hear from Chair Powell at 3:00pm this afternoon.  Arguably, that is the event of the day as all await to see if the trajectory of rate cuts is going to flatten out or not.

I cannot look at the data and conclude that the Fed will be very aggressive cutting rates going forward.  The futures market is now pricing in about 75bps of cuts, total, by the end of 2025.  That is a 50bp reduction in that view during the past month and one of the reasons the dollar remains strong.  I would not be surprised if there are even fewer cuts.  Right now, everything points to the dollar continuing to outperform virtually every other currency.

Good luck

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A Warning

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Though Trump has been leading the news
With folks asking who he will choose
As agency chiefs
That share his beliefs
For markets, today brings new cues
 
Inflation will soon be released
And though Jay claims he killed this beast
The data this morning
May well be a warning
Inflation, in fact, has not ceased

 

Source: tradingeconomics.com

Beauty (and everything else) is in the eye of the beholder.  So, what are we to make of the above chart which shows the past ten years’ worth of monthly Core CPI readings prior to this morning’s release.  Some eyes will travel to the peak in April 2021 (0.812%) and see a downward sloping line from there.  The implication is that the trend is your friend and that things are going well.  Others will gravitate to the June 2023 print (0.195%) and see that except for a blip lower in June 2024 (0.1%), the series looks like it may have bottomed and, if anything, has found a new home.

Remember, that if the monthly print is 0.3%, that annualizes to 3.7% Core CPI.  That seems pretty far above the 2.0% target that the Fed is shooting for and would call into question exactly why they are cutting interest rates.  In fact, you can look at the above chart and see that prior to the pandemic, core CPI on a monthly basis was below 0.3% every month except one, with many clearly down near the 0.1% level.

As much as Powell and his minions want to convince us that inflation is heading back to their goal and everything is ok, the evidence does not yet seem to be pointing in that direction.  For today, current median analyst expectations are for a headline of 0.2% M/M, 2.6% Y/Y and a core of 0.3% M/M, 3.3% Y/Y.  Even if the data comes as expected, it would seem very difficult to justify continuing to cut rates given the equity market remains essentially at all-time highs, while Treasury yields (-1bp today, +12bps yesterday) seem like they are starting to price in higher long-term inflation.

However, something interesting seems to be happening with the Fed speakers.  Richmond Fed President Barkin yesterday explained that things look pretty good, but declined to even consider forecasting where things will go.  As well, Minneapolis Fed President Kashkari indicated that while inflation has declined, it does not yet seem dead.  The Fed funds futures market is now pricing just a 62% probability of a rate cut in December.  One month ago, it was pricing an 84% probability.  As I have maintained, it seems increasingly difficult for the Fed to make the case that rate cuts are necessary given the economic data that we continue to see.  I understand that there are still a large group of pundits who believe things are much worse when you dig under the surface of the data, and I also understand that most people in the country don’t believe that things are going that well, hence the landslide election results for Mr Trump.  However, based on the data that the Fed allegedly follows, rate cuts seem difficult to support.  Today will be another piece of the puzzle.  If the data is hot, I expect risk assets to suffer more and the dollar to continue its rally.  If the data is soft, look for new records in stocks while the dollar retraces some of its recent gains.

With that in mind, let’s look at what happened overnight in markets.  Yesterday’s modest declines in the US market were followed by more selling than buying in Asia with the Nikkei (-1.7%) leading the way lower but weakness also seen in Australia (-0.75%), Korea (-2.65%), India (-1.25%) and Taiwan (-0.5%) as an indication of the general sense in the time zone.  The outlier here was mainland China (+0.6%) where hope remains eternal that the government will fire their bazooka.  In Europe, though, this morning is seeing a hint of red with most major indices lower by just -0.1% and Spain’s IBEX (+0.2%) even managing a small gain.  The commentary from the continent is over fears of how things will evolve with the new Trump administration and his threat of more tariffs on European exports.

But here’s something to consider.  If Trump is successful in quickly negotiating an end to the Russia/Ukraine war, won’t that be a huge benefit to Europe?  After all, if the war is over, they will be able to restart imports of cheap Russian NatGas which should have an immediate impact on their overall cost of energy, especially Germany, and help the economies there substantially.  I know they love to scream because they all hate Trump, but it seems like he could help them a lot if they would let him.  Oh yeah, US futures are a touch lower, -0.2%, at this hour (7:10).

Anyway, in the bond market, after yesterday’s rout in the US, yields are little changed this morning but in Europe, yields are climbing as they weren’t able to keep up with US yields yesterday.  So, on the continent, yields are higher between 2bps and 4bps after rising 4bps – 6bps yesterday.  In Asia, JGB yields jumped 4bps on the global rise in bond yields and are now back above 1.0%.  However, that has not been nearly enough to help the yen (-0.2%), which continues to weaken and is pushing back above 155.00 this morning.  

In the commodity markets, oil (+0.2%) is edging higher, but that seems to be consolidation after what has been a pretty awful week for the black sticky stuff.  OPEC reduced its demand forecasts for the 4th consecutive month, something else that is weighing on the price and, of course, the Trump administration is going to seek to make it much easier to explore for and produce more oil.  In the metals markets, gold (+0.5%) seems to have found a temporary bottom along with silver (+0.8%) although the damage has been substantial this week.  However, copper and aluminum remain under pressure as fears over continued weakness in China seem to be weighing on the price.

Finally, the dollar has stopped rising sharply, although it is not really declining very much, at least not vs. the G10 currencies.  In fact, vs. the G10, the dollar is softer by just 0.1% or so vs. the entire bloc other than the yen mentioned above.  However, vs. the EMG bloc, the dollar has ceded some more gains with KRW (+0.7%) the leader but MXN (+0.4%), CNY (+0.35%) and ZAR (+0.6%) all bouncing back after a week of substantial declines.  We all know nothing goes up or down in a straight line, so this consolidation is just that, it is not a trend change by any stretch.  A quick look at the MXN chart below, which is essentially what we have seen everywhere, explains just how insignificant the overnight movement has been relative to the recent trend.

Source: tradingeconomics.com

On the data front, aside from the CPI data, we hear from three more Fed speakers (Logan, Musalem and Schmid) so it will be interesting to see if they are starting to change their sense of how things are going to progress.  Of course, all eyes will be on Powell’s speech Thursday afternoon, but perhaps there are some clues to be had here.

It is not clear to me that anything has changed in the big picture.  The US economy continues to be the strongest one around and now has the added impetus of expectations for more positivity with the change in the administration.  In that environment, my long-term view on the dollar remains it has further to run.

Good luck

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Lickspittle

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The Fed has a banker named Jay
Who last week was quick to betray
His fervent belief
He can’t come to grief
If Trump wants to force him away
 
This morning his Journal lickspittle
Wrote glowingly ‘bout Jay’s committal
To stand strong and firm
And finish his term
No matter how much he’s belittled

 

First, on this Veteran’s Day holiday, let us all pause a minute and remember those veterans who gave their lives for our nation.

The reverberations of Donald Trump’s re-election last week continue to be felt around the world with comments from virtually every walk of life explaining their joy/distress at the outcome and trying to prognosticate what will play out in the future.  I will tell you that I have no idea how things will evolve, although I am hopeful that his administration will be able to reduce the size of the federal government as that can only be a benefit.

But one of the things that we learn about people during times of change, especially people who believe they are crucially important to the world, is just how much they believe they are crucially important to the world.  Nothing highlights this quite like the lead article in this morning’s WSJ titled, If Trump Tries to Fire Powell, Fed Chair Is Ready for a Legal Fight.  This is not to say that Powell doesn’t have an important role, he certainly does.  But this pre-emption of the entire question is a testimony of just how important he thinks he is.  

My one observation on this is that despite all the discussion that the Fed isn’t political, it is clearly a very political institution.  Nothing highlights that better than this Tweet from Joseph Wang (aka @FedGuy12), a commentator who spent a dozen years at the Fed and understands its inner workings quite well.  Under the rubric that a picture is worth 1000 words, take a look at Federal Reserve political contributions below and then ask yourself if the Fed is not only political, but partisan.  

Source: X @FedGuy12

It is important to recognize this as it also may help explain why the Fed is cutting interest rates despite GDP (currently 2.8%) and Core PCE (currently 2.7%) running far above their long-term expectations and Unemployment (currently 4.1%) running below their long-term expectations as per the below SEP from the September FOMC meeting.  If anything, I might argue they should be raising interest rates!

Source: fedreserve.gov

At any rate, the ramifications of this election outcome are likely to drive the market narrative for a while yet.

But overnight, there just wasn’t that much of interest, at least not that much new.  So, let’s take a look at overnight market activity.  After Friday’s latest record high closes in the US, the picture in Asia was less robust with Japanese equities basically unchanged on the day after Shigeru Ishiba was elected PM to run a minority government, while Hong Kong (-1.5%) and mainland Chinese (+0.7%) shares went in opposite directions.  Chinese financing data was released that was mildly disappointing, but there are several stories about how the government is going to reacquire land that is currently in private hands but not being used and repurpose it for benefit.  The rest of the region had many more laggards than gainers, perhaps on concerns that Trump will be imposing tariffs throughout the region.  As to Europe, despite all the pearl clutching by the leadership there, equity investors are excited with gains seen across the board (DAX +1.3%, CAC +1.2%, FTSE 100 +0.8%).  US futures at this hour (7:30) are continuing their ride higher, up 0.4%.

In the bond market, Treasuries aren’t really trading today with banks closed.  In Europe, sovereign yields have edged down between 1bp and 2bps, perhaps feeling a little of that equity euphoria, as there was precious little in the way of news or commentary to drive things.

In the commodity space, oil (-1.7%) is under further pressure as broadly slower global growth undermines demand while prospects of the Trump administration fostering significant additional drilling opportunities helps build the supply side.  However, NatGas (+7.0%) is soaring this morning as Europe, notably Germany, is suffering from dunkelflaute (maybe the best word I have ever heard) which means ‘a period of low wind and solar power generation because it is cloudy, foggy and still’, and so they need to buy a lot more NatGas to power the economy.  In fact, NatGas is higher by nearly 15% in the past month although remains substantially cheaper in the US than in Europe and Asia.  My take is this discrepancy cannot last forever.  As to the metals markets, they are under pressure again this morning with both precious (Au -0.9%, Ag -0.3%) and industrial (Cu -0.5%, Al-1.4%) feeling the pain.  

A key driver in the metals space is the dollar, which is rallying against all its counterparts this morning quite robustly.  The euro (-0.6%) is back to levels last briefly touched in April, but where it spent more time a year ago, as it seems to be heading to 1.05 and below.  Meanwhile, JPY (-0.8%) is also feeling the heat while NOK (-0.7%) is pressured by both the dollar’s general strength and the oil weakness.  In the EMG bloc, MXN (-1.3%) is having a rough go as the tariff talk heats up, but we have also seen weakness in EEMEA with ZAR (-1.4%), PLN (-1.0%) and HUF (-1.2%) all under pressure this morning.  Not to be outdone, Asian currencies, too, are selling off with CNY (-0.3%) back above 7.20 for the first time since August while THB (-0.9%), MYR (-0.7%) and SGD (-0.6%) demonstrate the breadth of the move.

With the holiday, there is no data to be released today, but this week brings CPI amongst other things.

TuesdayNFIB Small Biz Optimism91.9
WednesdayCPI0.2% (2.6% Y/Y)
 Ex food & energy0.3% (3.3% Y/Y)
ThursdayPPI0.2% (2.3% Y/Y)
 Ex food & energy0.3% (2.9% Y/Y)
 Initial Claims224K
 Continuing Claims1895K
FridayRetail Sales0.3%
 -ex autos0.3%
 Empire State Mfg-1.4
 IP-0.3%
 Capacity Utilization77.2%

Source: tradingeconomics.com

In addition to this data, we hear from 11 different Fed speakers this week, including Chairman Powell again at 3:00pm on Thursday afternoon.  It is difficult to believe that the message from last week is going to change, but you never know.  However, I expect that every one of them is going to be explaining that things are good, but they are cutting rates to ensure things remain that way as they consistently congratulate themselves on having slain inflation.  I hope they are right…I fear they are not.

For now, though, the US economy remains the strongest in the world (7% budget deficits will help prop up growth after all) and capital continues to flow in this direction.  I see no reason for the dollar to fall anytime soon.  Whatever problems lie ahead, I believe they are over the metaphorical horizon and other than a few doomporn purveyors, not in the market’s view.

Good luck

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Nothing But Fearporn

Posted on by

Said Logan, right now things are cool
With loads of reserves in the pool
And if I’m correct
The likely effect
Is rates will remain our key tool
 
As such, talk of balance sheet woes
Is nothing but fearporn, God knows
We’ll let bonds mature
Though we are unsure
Of how many we need dispose

 

“If the economy evolves as I currently expect, a strategy of gradually lowering the policy rate toward a more normal or neutral level can help manage the risks and achieve our goals,” explained Dallas Fed President Lorrie Logan on Monday. “However, any number of shocks could influence what that path to normal will look like, how fast policy should move and where rates should settle.”

In other words, we want to keep up appearances but we have no real idea how things are going to play out and so whatever we think our policies are going to be right now, they are subject to changes at any time.  It shouldn’t be surprising that the Fed doesn’t really know where things are going to go, after all, predicting the future is very hard.  But for some reason, many folks, both market focused and politicians, seem to believe they should be able to forecast well and control the outcomes.

Based on the market reaction to Logan’s comments, market participants, at least, are losing some of that confidence.  Treasury yields jumped 11bps in the 10-year dragging the entire yield curve higher along with all of Europe.  And perhaps more ominously for the Fed’s wish list, mortgage rates also rocketed to their highest level since July.  I might suggest market participants are losing their belief that the Fed is going to continue to cut interest rates as many had believed.  Fed funds futures have reduced their cut probabilities by nearly 10 points compared to yesterday as the latest example of this issue.  

And you know what else continues to benefit as those interest rates refuse to decline?  That’s right, the dollar continues to rally steadily against all comers.  Using the DXY as a proxy, the greenback has rebounded 3% from its levels around the time of the last Fed meeting as per the below chart.  I assure you, if I am correct that the Fed cuts 25bps in November and then doesn’t cut in December, the dollar will be much higher still.  Something to watch for!  

Source: tradingeconomics.com

In fact, there were four Fed speakers yesterday and three of them, including Logan, sounded more cautionary in their view of the future path of rates.  However, uber dove Mary Daly from the SF Fed is still all-in for many more cuts to come.  And this is the current situation at the Fed, I believe.  There are FOMC members who remain in the “we must cut rates at all costs” camp, who despite the evidence of the data they supposedly track remaining stronger than expected want lower rates, and there are those who are willing to reduce the pace of cuts, but still want lower rates.  This tells me that the Fed is going to continue to cut rates regardless, and so the bond market is going to become the arbiter of financial conditions.  Recent bond market movements seem more likely to be a harbinger of the future than an aberration, at least unless/until the economy weakens substantially.  In fact, you can see that the relation between bond yields and the dollar is quite strong now, something I suspect will remain true for a while going forward.

And that was really all that we had as the overnight session brought us virtually nothing new.  So, a quick recap of the overnight shows that after a lackluster session in the US on low volumes, Asia had more laggards than leaders with Tokyo (-1.4%) and Australia (-1.7%) dominating the story although China (CSI 300 +0.6%, Hang Seng +0.1%) managed to buck the trend.  The latter two, though, seemed like reactionary bounces from recent declines.  In Europe, bourses are all red this morning led lower by Spain’s IBEX (-1.1%) but seeing weakness everywhere (CAC -0.7%, FTSE 100 -0.7%, DAX -0.25%).  And, at this hour (7:45), US futures are lower by -0.5% or so.

After yesterday’s dramatic rise in yields in the US, we are seeing a continuation this morning with Treasuries edging higher by 1bp but European sovereigns all higher b between 4bps and 5bps.  That seems to be catching up to the last of the afternoon Treasury move yesterday.  As I mention above, I see the trend for yields in the US to be higher, and that should impact yields everywhere.

In the commodity markets, once again, demand is increasing and we are seeing gains in oil (+1.1%), gold (+0.6% and new all-time highs), silver (+1.7%) and copper (+0.9%).  The financial narrative is turning more and more to inflation concerns and the fact that commodities remain an undervalued and important segment in which to have exposure.  I am personally long throughout this space and believe there is much further to run here.

Finally, after the dollar’s blockbuster day yesterday, it has paused for a rest with the noteworthy gainers today all in the commodity bloc (AUD +0.5%, NZD +0.55%, MXN +0.2%, ZAR +0.2%, NOK +0.4%) with most other currencies actually a bit softer vs. the buck.  Keep an eye on JPY (-0.2%) which is now firmly above the 150 level and is likely to begin to see more discussion about potential intervention soon.

There is no data of note this morning although we do hear from Philly Fed president Harker.  It will be interesting to hear if he is in the dovish or uber dovish camp, as there appear to be no hawks left on the FOMC. 

Until the election in two weeks, I suspect that volumes will remain low but trends will remain intact, so higher yields and a higher dollar seem most likely to be in our future.

Good luck

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Open and Shut

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The FX Poet will be in Nashville at the AFP Conference October 21-22, speaking about effective ways to use FX options in a hedging program.  Please come to the presentation on Monday at 1:45 in Grand Ballroom C2 if you are there.  I would love to meet and speak.
 
The great thing about recent data
Is nobody thinks it will matta
It’s open and shut
The Fed’s gonna cut
As ‘flation ambitions they shatta
 
In Jay’s mind, the risk tradeoff’s clear
As stocks work to find a new gear
However, for debt
They’re making the bet
The problems won’t hit til next year

On this Columbus Day holiday, US cash markets are closed although futures are trading, so no stock or bond market activity today.  The FX market will be open, as always, although I suspect liquidity will be less than usual, especially once Europe goes home at noon so hopefully, you don’t have much to do today in the way of hedging.

As it happens, there was not a lot of news overnight to discuss, although China did manage to once again disappoint with respect to their fiscal support announcement on Saturday, not offering up even a big picture number, let alone specific programs, that they are considering.  Interestingly, this did not deter the new China stock bulls, with the CSI 300 (+1.9%) rallying sharply, but this is becoming a sentiment story, not a data driven one.  Someone on X asked the question about why Xi was not doing more, and my view has become that he recognizes to truly get the economy going again he will need to cede some of the power he has spent the past 10 years amassing.  I sincerely doubt he is willing to do that, and since his life won’t change regardless of the amount of stimulus, in the end, holding power is far more important to him.

But let’s go back to the data driven approach and its pluses and minuses.  This morning’s WSJ had an articleby James Mackintosh titled, “The Fed Has a Dependency Problem That Needs Fixing”, and it is his view that data dependence is the current Achilles Heel for Powell and friends.  Now, I won’t dispute that the market’s tendency to extrapolate one data point out to infinity can have market consequences, but I think the point Mr Mackintosh misses is that this is a problem entirely of the Fed’s own making.  Nobody instructed them to offer their views, other than the semi-annual testimony before Congress.  Nobody is forcing FOMC members to be out blathering virtually every day (in fact, two of them, Waller and Kashkari, will be speaking today despite markets being closed).  Forward Guidance was Benny the Beard’s brainstorm, it is not a Congressional mandate, it is not in the Fed’s charter, it is entirely their own.

So, if too much forward guidance is a problem, the Fed can simply stop it.  There is no doubt the recent data releases have been somewhat confusing, with more strength than most economists and analysts have forecast, and there is no doubt that any given month’s data point is subject to certain random fluctuations and revisions.  However, consider if the Fed was not trying to guide the market to whatever their preferred outcome may be.

If there was no Forward Guidance, then each individual investor would have to analyze the current situation themselves, get their best estimate of how they anticipated the future to evolve, and position themselves accordingly.  In today’s world, there is a lot of data pointing in different directions.  Absent the Fed trying to sway opinion, position sizes would be greatly reduced, and the large reversals in markets like we saw in the wake of the recent rate cut and subsequent NFP and CPI releases, would likely be far less significant.  

When the Fed explains that they are going to keep rates lower for longer (as they did in the wake of the GFC and again post covid) that is a clear signal to investors to load up on assets that perform well in a low-rate environment (i.e. stocks).  When they change that view…oops!  That is what we saw in 2022 when they flipped the script and went from transitory inflation to persistent inflation.  Everybody who was long both stocks and bonds suffered.  

But let’s run a thought experiment.  If the Fed gave no Forward Guidance, and merely adjusted rates as they saw fit, investors would have had significantly less confidence that regardless of what had clearly become an inflation problem, the Fed was going to maintain low interest rates.  There would have been a much more gradual move out of risk assets as investors determined inflation was a problem, and the Fed wouldn’t have had all that egg on their face when they had to admit they made a mistake about inflation.

In the end, I disagree with Mackintosh that the Fed should essentially ignore the data, but I agree that they shouldn’t talk about it at all.  In fact, I think we would all be far better off if none of them ever said a word!

Enough of my diatribe.  Let’s see how the rest of the world’s markets behaved overnight.  While mainland Chinese stocks performed well, Hong Kong (-0.75%) did not.  Japan was closed for National Sports Day, although the broad Asia look was that markets there followed Friday’s US rally as well.  However, this morning in Europe, the picture is mixed with some gainers (DAX, IBEX) and some laggards (CAC, FTSE 100) and none of the moves more than 0.3%.  The only data overnight was Chinese Trade (reduced Trade surplus of $81.7B) and Chinese financing which was modestly disappointing despite the recent efforts at goosing things there.  US futures are trading this morning and at this hour (7:00) they are mixed with modest gains and losses of ~0.25%.

With Japan closed along with the US, it should be no surprise that bond market activity is extremely limited with yields essentially unchanged this morning from where they were at Friday’s close.  However, remember that 10-year Treasury yields are higher by nearly 50bps since the day before the FOMC meeting.  This is an important signal that market participants are far more concerned about inflation than the Fed.  On this subject, I think the market is correct.

In the commodity markets, oil (-2.4%) continues its recent decline as the long awaited and feared Israeli response to Iran’s missile attacks seems to have been postponed further.  The absence of that supply concern alongside the lack of Chinese stimulus, and by extension demand, has weighed heavily on the market.  Gold is unchanged this morning although we are seeing some softness in the industrial metals with both silver and copper softer today.

Part of that metals weakness is due to the fact that the dollar continues to rise against all forecasts.  This weekend there was a meeting of the old Soviet nations, the CIS (absent Ukraine of course) and they pledged to stop using dollars in their trade.  This is in the lead-up to the BRICS conference to be held next week in Kazan, Russia, where once again many claim that this group of nations will create their own currency in their efforts to get away from the dollar’s hegemony.  Whether or not they formally do so, I have yet to see a path that includes a cogent rationale for anyone to use this currency, especially if it is backed by a series of nonconvertible currencies like the CNY, BRL and INR.  But it does generate clicks in the doomporn sphere.  

But back in the real world, the dollar is just grinding higher vs everything this morning with NOK (-0.8%) suffering on oil’s weakness and AUD (-0.5%) and NZD (-0.5%) under pressure because of metals weakness and lack of Chinese stimulus.  ZAR (-0.8%) is also feeling the metals weakness but JPY (-0.4%) and CNY (-0.35%) are all softer this morning.  In other words, it is business as usual.  In fact, for those of you with a market technical bias, a quick look at the euro chart seems to define the concept of a double top.

Source: tradingeconomics.com

On the data front, aside from loads more Fedspeak this week, and the ECB monetary meeting on Thursday, the big data print in the US is Retail Sales, also on Thursday.

TuesdayEmpire State Manufacturing2.3
ThursdayECB Rate Decision3.25% (current 3.5%)
 Initial Claims255K
 Continuing Claims1870K
 Retail Sales0.3%
 -ex Autos0.2%
 Philly Fed3.0
 IP-0.1%
 Capacity Utilization77.8%
FridayHousing Starts1.35M
 Building Permits1.45M

Source: tradingeconomics.com

Adding to today’s Fedspeak, we hear from eight more speakers this week. With the Fed funds futures market pricing a 14% probability of no cut at all in November, which would be remarkable given the 50bp cut they made last month, it strikes me that there will be very little new from the speakers.  Rather, if the data this week comes in hotter than forecast, that is going to be the market driver.  I think it is fair to say the Fed has made a hash of things lately.  As long as the data continues to look good, though, I have to believe that fears of renewed inflation and higher rates are going to support the dollar.

Good luck

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Condemned to Damnation

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The Chinese returned from vacation
But hopes for more subsidization
Were rapidly dashed
With early gains trashed
And Hong Kong condemned to damnation
 
Meanwhile, what we heard from the Fed
Was further rate cuts are ahead
They all still believe
That they will achieve
Their goal and inflation is dead

 

Talk about buzzkill.  The Chinese Golden Week holiday is over and all the hopes that the National Development and Reform Commission Briefing would highlight new stimulus as well as further details of the programs announced prior to the holiday week were dashed.  Instead, this group simply confirmed that they were going to implement the previously announced plans and insisted that it would be enough to get the economy back to its target growth rate of 5.0%.  You may recall that the government had promised funds to support the stock market and some efforts to support the housing market, but there was little in the way of direct support for consumers.  While the initial market response to the stimulus measures was quite positive, there is a rapidly growing concern that those measures will now fall short.  In the end, much of the joy attached to the stimulus story has evaporated.  

The market response was telling as while onshore stocks rallied (CSI 300 +5.9%) they closed far below their early session highs and the Hang Seng (-9.4%) in Hong Kong, which had been open all during the Golden Week holiday and rallied steadily through that time, retraced sharply, giving back all those gains and then some (see below). 

Source: Bloomberg.com

In the end, it is difficult to look at the Chinese story and feel confident that the currently announced stimulus packages are going to be sufficient to make a major dent in the problems there.  It appears that the limits of a command economy may have been reached, a situation that will not benefit anyone.

Turning to the first batch of Fed speakers, yesterday we heard from Governor Adriana Kugler, St Louis Fed president Alberto Musalem and Chicago Fed president Austan Goolsbee.  While Mr Goolsbee explained, “I am not seeing signs of resurgent inflation,” it does not appear he is really looking.  As to Ms Kugler, she “strongly supported” the 50bp cut and when asked about the strong NFP report explained that looking through the data, “several metrics point toward labor-market cooling”, despite the strong report.  Finally, Mr Musalem, although he supported the 50bp cut, remarked, “Given where the economy is today, I view the costs of easing too much too soon as greater than the costs of easing too little too late.”

Net, it appears that recent data upticks have not had any impact on their views that they must cut rates further and are prepared to do so every meeting going forward.  The Fed funds futures market has now priced 25bp rate cuts into both the November and December meetings, although that is reduced significantly from the nearly 100bps that was priced prior to the NFP report.

Away from those stories, though, there was not much other news of note overnight.  Russia/Ukraine has moved to page 32 of the newspapers and is not even discussed anymore.  Israel/Hamas/Hezbollah/Iran has more tongues wagging but at this point, it has become a waiting game for Israel to respond to the missile barrage from Iran last week.  Given we are between Rosh Hashanah and Yom Kippur, it seems unlikely to me that we will see anything prior to the weekend.  China fizzled after vacation.  The US election remains a tight race at this point with no clear outcome.  Hurricane Helene and the aftermath is being superseded by Hurricane Milton, due to hit the Tampa area shortly, but again, the latter two, while horrific tragedies, or potential tragedies, are not really market stories.

So, what’s driving things?  Arguably, interest rate policies and bond markets are having the biggest impact on financial markets right now.  With that in mind, the fact that 10-year Treasury yields are now back above 4.0% for the first time since August seems to be the main event.  Why, you may ask, would bond yields have backed up so far so fast?  Ultimately, it appears that bond investors are losing confidence in the central bank inflation story, the idea that they have it under control.  First off, oil prices, though lower today by -1.9%, have still gained more than 8.3% in the past week with gasoline prices higher by nearly 7% in the same period.  This does not bode well for lower inflation prints going forward.  Second, the combination of the much stronger than expected NFP report and the Fed’s willful ignorance of the implications is also tipping the marginal investor toward seeing more inflation going forward.

Ok, so how have these things impacted markets?  Well, aside from China/HK and following yesterday’s US declines, there were far more laggards (Japan, Singapore, Korea, Australia) than leaders (India) across Asia with Tokyo (-1.0%) the next worst performer.  In Europe, all the screens are red this morning led by the UK (-1.1%) but with losses between -0.2% in Germany after a much better than expected IP reading, to -0.6% in France.  Oftentimes, it seems like Europe is trading on yesterday’s US news, and that is the case today as US futures are pointing higher by about 0.4% at this hour (7:40).

Bond yields, which have been climbing for the past week, are little changed this morning, with neither Treasuries nor European sovereigns showing any movement of note.  However, one need only look at the chart below to see the trend over the past month.

Source: tradingeconomics.com

Aside from the oil retreat mentioned above, which seems to be a response to the absence of that Israeli action so widely expected, copper (-2.6%) is the laggard as disappointment over the Chinese stimulus dud pushed down demand expectations.  Gold (+0.3%) though, remains in demand and is hovering just below its recent all-time highs.

Finally, the dollar is backing off a bit this morning, although as evidenced by the chart below of the DXY, it has been on a bit of a tear for the past week, so consolidation should not be a surprise.

Source: tradingeconomics.com

However, overall, today’s price activity has been relatively muted with all G10 currencies within 0.2% of yesterday’s closing levels and the biggest movers in the EMG bloc (PLN +0.4%, ZAR -0.4%) hardly showing much more motion.  One exception is IDR, where the central bank intervened overnight after six consecutive days of rupiah weakness which saw the currency decline -4.5%.

On the data front this morning, the NFIB Small Business Optimism Index was released at a slightly softer than expected 91.5 although the Uncertainty sub index it a record high of 103 indicating small businesses are in a tough spot.  Otherwise, the only number is the Trade Balance (exp -$70.6B) and then a bunch more Fed speakers, all different ones than yesterday.  We also see the 3-year Note auction, so that may give us some clues as to the demand story for Treasuries ahead of the CPI data on Thursday.

The ongoing conflicting data has many, if not most, investors confused.  I believe that people will be seeking more clarity on Thursday and so until then, absent another geopolitical shock, we are likely to see modest market movements overall.  However, with the Fed hell-bent on cutting, I continue to fear inflation starting to reaccelerate and the dollar starting a more substantive decline.

Good luck

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Surprise!

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Ishiba explained
He was just kidding about
Tight money…surprise!

 

So, yesterday’s biggest mover was JPY (-2.1%), where the market responded to comments by new PM Ishiba that all his previous comments regarding policy normalization were not really serious (and you thought Kamala flip-flopped!)

Here are his comments in the wake of that massive 12% decline in the Nikkei back in early August:

“The Bank of Japan (BOJ) is on the right policy track to gradually align with a world with positive interest rates,” ruling party heavyweight Shigeru Ishiba told Reuters in an interview.

“The negative aspects of rate hikes, such as a stock market rout, have been the focus right now, but we must recognize their merits, as higher interest rates can lower costs of imports and make industry more competitive,” he said.

And here are his comments after meeting with BOJ Governor Ueda Wednesday morning in Tokyo:

“From the government’s standpoint, monetary policy must remain accommodative as a trend given current economic conditions.”

See if you can tell the difference.  The below chart includes the market response to his election last week as well as its response since uttering those last words early yesterday morning.

Source: tradingeconomics.com

Remember the idea that the carry trade was dead and completely unwound?  Well, now the talk is its coming back with a vengeance between Powell sounding less dovish, Ishiba sounding more dovish and then yesterday’s ADP Employment Report printing at a higher-than-expected 143K.  Maybe all those rate cuts that had been priced are not going to show up in traders’ Christmas stockings after all.  Certainly, the Nikkei (+2.0%) was pleased with the weaker yen which has fallen further this morning (-0.2%) after further comments from BOJ member Noguchi calling for more time to evaluate the situation before considering tighter policy.  In fairness, though, Noguchi-san is a known dove and voted against the rate hikes back in July.  Summing it all up here, it is hard to make a case currently for the yen to strengthen too much from here.  Rather, a test of 150 seems the next likely outcome.

In England, the Old Lady’s Guv
Explained that he’s really a dove
He’ll be more aggressive
Though not quite obsessive
While showing investors some love

The other big mover this morning is the British pound (-1.1%) which is responding to an interview BOE Governor Bailey had in The Guardian where he explained he could become “a bit more aggressive” in their policy easing stance provided inflation data continues to trend lower.  Now, prior to the interview, the OIS market was already pricing in a 25bp cut at the next meeting in November, and 45bps of cuts by year end, and it is not much changed now.  But for whatever reason, the FX market decided this was the news on which to sell pounds.  

Remember, as I’ve repeatedly explained, the dollar’s demise is likely to be far slower than dollar bears believe because now that the Fed has begun cutting rates, and nothing is going to stop them going forward for a while, other central banks will feel empowered to cut as well.  The only way the dollar falls sharply is if the Fed is the most dovish central bank of the bunch, but Monday, Chairman Powell made clear that was not the case.  In fact, yesterday, Richmond Fed president Barkin was the latest to explain that things look good, but they are in no hurry to cut aggressively.  Other central banks are now in a position to ease policy more aggressively, something many had been seeking to do as economic activity was slowing in their respective countries, without the fear of a currency collapse. 

It was just a few days ago that I highlighted key technical levels the market was focused on, which if broken might herald a much weaker dollar.  Across the board, we are more than 2% from those levels (EUR 1.12, GBP 1.35, DXY 100.00) and traveling swiftly in the other direction.  A quick peek at the chart below shows that while the exact timing of these moves was not synchronized, the outcome is the same.

Source: tradingeconomics.com

Moving beyond the FX market, where the dollar is stronger literally across the board, the economic story continues to muddle along.  Services PMI data was released this morning with most of Europe looking a bit better, although the Italians were lagging, but not enough to get people excited about European assets in general.  Equity markets on the continent are mixed with both the DAX (-0.6%) and CAC (-0.8%) under pressure while Spain’s IBEX (+0.1%) and the FTSE 100 (+0.25%) buck the trend on the back of Spain’s best in class PMI data and, of course, the UK rate cut frenzy.  As to last night’s Asian markets, while China remains closed, the Hang Seng (-1.5%) gave back some of yesterday’s gains and the rest of the region was unconvinced in either direction.  While US markets eked out the smallest of gains yesterday, futures this morning are pointing lower by -0.4% or so at this hour (6:45).

In the bond market, Treasury yields are higher by 3bps this morning, as the market absorbs the idea that the Fed may not be cutting in 50bp increments each meeting and traders responded to a much better than expected ADP Employment Report yesterday (143K, exp 120K) so are prepping for a good NFP number tomorrow. Meanwhile, European sovereign yields are all higher by between 5bps and 7bps as they catch up to yesterday’s Treasury move, much of which occurred after European markets were closed.  One thing to keep in mind here is that bond markets, at least 10-year and longer maturities, are far more concerned with the inflation outlook than the central bank discussion.  Right now, as the world awaits Israel’s response to the Iranian missile attack, concerns are rife that oil prices could move much higher and take inflation readings along for the ride.  If you add that to the idea that 3% is the new 2% for central bank inflation targets, something which is also gaining credence in the market, the case for higher bond yields is strong.

Speaking of oil markets, once again this morning the black sticky stuff is higher (+2.0%) amid those Middle East conflagration fears.  As I highlighted yesterday, if Israel were to attack Iran’s oil fields and knock a large portion offline, I would expect oil to get back to $100 in a hurry.  And if the damage was sufficient to keep it offline for many months, we could stay there.  However, the combination of the stronger dollar and higher oil prices has taken a toll on the metals markets with all the major metals weaker this morning (Au -0.5%, Ag -1.1%, Cu -1.5%).  This strikes me as a short-term phenomenon as the fundamental supply/demand issues remain in favor of higher prices and anything that drives inflation higher will help price as well.  But not today.

As to the dollar, I have already discussed its broad-based strength with gains against literally all its G10 and EMG counterparts.  It will take some pretty bad US data to change this story today.

Speaking of the data, as it’s Thursday, we get the weekly Initial (exp 220K) and Continuing (1837K) Claims data as well as ISM Services (51.7) and Factory Orders (0.0%).  Yesterday, in a surprise, EIA oil inventories rose, a welcome outcome, but not enough to offset the Middle East fears.  The only Fed speaker on the calendar today is Atlanta Fed president Bostic, one of the more hawkish members, so my guess is he is likely to continue to preach moderation in rate cuts.  Speaking of the Atlanta Fed, their GDPNow reading fell to 2.5% for Q3 after the weaker than expected construction spending the other day, but it remains above the Fed’s estimated long-term trend growth rate.

Putting it all together, I can see no good reason for the dollar to reverse this morning’s gains absent a Claims number above 250K.  The hyper dovishness that had been a critical part of the dollar decline story has been beaten back.  Of course, tomorrow brings the NFP report, so anything can still happen.  

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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Miles Off Base

Posted on by 
This poet was miles off base

As Powell, more growth, wants to chase

So, hawks have been shot

With nary a thought

While doves snap all stocks up apace.



It seems clear that Jay and the Fed

Decided inflation is dead

Through Q1 at least

Bulls will have a feast

Though after, take care where you tread

It turns out that not only were my tail risk ideas wrong, I was on the wrong side of the distribution!  Powell has decided that the soft-landing narrative is the best estimator of the future and wants to make sure the Fed is not responsible for a recession.  Concerns over inflation, while weakly voiced, have clearly dissipated within the Eccles Building.  I hope they are right.  I fear they are not.

In fairness, once again, yesterday I heard a very convincing argument that inflation was not only going to decline back to the Fed’s target of 2.0%, but it would have a 1 handle or lower by the middle of 2024 based on the weakening credit impulse that we have seen over the past 18 months.  And maybe it will.  But, while there is no question that money supply has been shrinking slowly of late, which has been a key part of that weakening credit impulse story, as can be seen from the chart below based on FRED data from the St Louis Fed, compared to the pace of M2 growth for decades, there are still an extra $3 trillion or so floating around the economy.  Iit seems to me prices will have a hard time falling with that much extra cash around.

Of course, there is one other place that money may find a home, and that is in financial assets.  So, perhaps the outcome will be a repeat of the post-GFC economy, with lackluster growth, and lots of money chasing financial assets while investors lever up to increase returns.  My guess is that almost every finance official in the world would take that situation in a heartbeat, slow growth, low inflation and rising asset prices.  The problem is that series of events cannot last forever.  As is usually the case with any negative outcome, the worst problems come from the leverage, not the idea.  When things are moving in one’s favor, leverage is fantastic.  But when they reverse, not so much.

A little data is in order here.  According to Statista, current global GDP is ~$103 trillion in current USD, current global stock market capitalization is ~$108 trillion, and the total amount of current global debt is ~$307 trillion according to the WEF.  In a broad view, the current debt/equity ratio is about 3:1 and the current debt/sales ratio is the same.  While this is not a perfect analogy, usually a debt/equity ratio of 3.0 is considered pretty high and a company that runs that level of debt would be considered quite risky.  Now, ask yourself this, if economic activity only generates $108 trillion, how will that >$300 trillion of debt ever be repaid?  The most likely answer is, it never will be repaid, at least not on a real basis.

If you wonder why central bankers favor lower interest rates, this is the primary reason.  However, at some point, there is going to be more discrimination between to whom lenders are willing to lend and who will be left out because they are either too risky, or the interest rate demanded will be too high to tolerate.  When considering these facts, it becomes much easier to understand the central bank desire to get back to the post-GFC world, doesn’t it?  And so, I would contend that Chairman Powell has just forfeited his efforts to be St Jerome, inflation slayer. 

The implication of this policy shift, and I would definitely call this a policy shift, is that the near future seems likely to see higher equity prices, higher commodity prices, higher inflation, first higher, then lower bond prices and a weaker dollar.  The one thing that can prevent the inflation outcome would be a significant uptick in productivity.  While last quarter we did see a terrific number there, +5.2%, the long-term average productivity growth, since 1948 is 2.1%.  Since the GFC, that number has fallen to 1.5%.  We will need to see a lot more productivity growth to keep goldilocks alive.  I hope AI is everything the hype claims!

Today, Madame Christine Lagarde

And friends are all partying hard

Now that Jay’s explained

Inflation’s restrained

And rate cuts are in the vanguard



This means that the ECB can

Lay out a new rate cutting plan

The doves are in flight

Which ought to ignite

A rally from Stuttgart to Cannes

Let’s turn to the ECB and BOE, as they are this morning’s big news, although, are they really big news anymore?  Both these central banks have been wrestling with the same thing as the Fed, inflation running far higher than target, although they have had the additional problem of a much weaker economic growth backdrop.  As long as the Fed was tightening policy, they knew that they could do so as well without having an excessively negative impact on their respective economies.  But given that pretty much all of Europe is already in recession, and the UK is on the verge, their preference would be to cut rates as soon as possible.  

But yesterday changed everything.  Powell’s bet on goldilocks has already been felt across European markets, with rallies in both equity and bond markets in every country.  The door is clearly wide open for Lagarde and Bailey to both be far more dovish than was anticipated before the FOMC meeting.  And you can be sure that both will be so.  While there will be no rate cuts in either London or Frankfurt today, they will be coming soon, likely early next year.  

At this point, the real question is which central bank will be cutting rates faster and further, not if they will be cutting them at all.  My money is on the ECB as there is a much larger contingent of doves there and the fact that Germany and northern European nations are already in recession means that the hawks there will be more inclined to go along for the ride.  Regardless, given the Fed has now reset the central bank tone to; policy ease is ok, look for it to happen everywhere.

Right now, this is all that matters.  Yesterday’s PPI data was soft, just adding fuel to the fire.  Inflation data that was released this morning in Sweden and Spain saw softer numbers and while Retail Sales (exp -0.1%, ex autos -0.1%) are due this morning along with initial Claims (220K), none of this is going to have a market impact unless it helps stoke the fire.  Any contra news will be ignored.

Before closing, there are two things I would note that are outliers here.  First, Japanese equity markets bucked the rally trend, with the Nikkei sliding -0.7% and the TOPIX even more (-1.4%) as they could not overcome the > 2% decline in USDJPY yesterday and the further 1% move overnight.  That very strong yen is clearly going to weigh on Japanese corporate profitability.  The other thing is that there is one country that is not all-in on the end of inflation, Norway.  This morning, in the wake of the Fed’s reversing course, the Norges Bank raisedrates by 25bps in a total surprise to the markets.  This has pushed the krone higher by a further 2.3% this morning and nearly 4% since the FOMC meeting.  

As we head toward the Christmas holidays and the beginning of a new year, it seems like the early going will be quite positive for risk assets and quite negative for the dollar.  Keep that in mind as you consider your hedging activities for 2024.

Good luck

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