Tag Archives: investing

More Than a Tweet

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In Davos, the global elite
Were treated to more than a Tweet
The president spoke
And in one broad stroke
Explained that he won’t be discreet
 
For oil, he wants prices falling
For Europe, he said it’s appalling
That nations don’t pay
Enough to defray
The costs of the war they’re forestalling

 

If, prior to yesterday, European leaders weren’t sure how things were going to play out now that Mr Trump is back in office, they have a whole lot better understanding now.  I imagine that all their fears were realized when Trump spoke via video at the WEF meeting in Davos, Switzerland.  It’s funny, Argentine president Javier Milei has been calling out the globalist agenda since his election last year and Europe didn’t care and didn’t change their behavior.  I guess that makes sense because the European press would never allow the narrative to change for a minor player like that.  Alas, for the European narrative now, the US, one of their largest trading partners and the nation that insures their safety via NATO membership, is calling them out for their behaviors, whether it is the rarely discussed tariffs they impose on US imports, or the lack of funding for a war they claim is critical to continue in Ukraine, and they are suddenly aware they better reconsider their positions. 

It will be very interesting to watch if things change in Europe (I think they will) and how quickly these changes will come (that could take more time).  Arguably, the biggest problem the current  European leaders have is that there are already large segments of their populations that are unhappy and have been voting accordingly, whether for AfD in Germany, or the RN in France to name two.  Trump’s comments are going to only foment more support for those positions.  I suspect the elections upcoming in Europe are going to see a further rightward swing, or perhaps simply a further swing against the incumbents given what appears to be a significant amount of dissatisfaction amongst the electorate.  No matter your view of Trump’s policies, we all must recognize he is a remarkable political force!

Fifty basis points
Is now Japan’s new baseline
Can it go higher?

As widely expected, the BOJ hiked its base rate by 25bps last night to 0.50%, the highest levels since October 2008.  The immediate market response, as you can see in the chart below, was for the yen to rally (dollar decline) almost one full percent despite interest rate markets having fully priced in the hike.  However, as you can also see, the yen has given back virtually all those gains in the wake of Ueda-san’s press conference where he explained the BOJ was not “seriously behind the curve” which was taken as meaning that it will be a while before they move again.  

Source: tradingeconomics.com

While JGB yields did perk up 2bps on the session, it hardly seems like the start of a rout.  And, as I highlighted yesterday, the interest rate differential does not seem likely to have changed enough to alter investor plans. Going forward, I expect the yen to be entirely beholden to the dollar’s broad movement.  If, as I suspect, the market starts to price in a more hawkish Fed, USDJPY is likely to go back and test its highs from last summer.

Ok, let’s move on to the overnight market action.  Once again, US equities rallied yesterday, although at this hour (7:10), futures are essentially unchanged.  In Asia, Japanese shares shed early gains after the BOJ rate hike and Ueda presser and closed unchanged on the day.  However, both Hong Kong (+1.9%) and China (+0.8%) rallied on the news that Trump and Xi had a “friendly” conversation as traders and investors took that to mean that tariffs on Chinese goods were not coming right away.  As to the rest of Asia, once again there were both gainers (Korea, Taiwan, Australia) and laggards (India, Indonesia, Philippines) with the rest showing little net movement.  

In Europe, the picture is also mixed as the CAC (+0.9%) is leading the way higher as investors want to believe that Trump’s call for lower interest rates as well as lower oil prices will help the European economy, especially the luxury sector in France.  But elsewhere in Europe we see Germany (+0.3%) a bit higher while Spain (-0.4%) and the UK (-0.4%) are lagging with the former suffering from rising energy prices while the ongoing political mess in the UK has investors steering clear of the Kingdom for now.

In the bond market, Treasury yields are unchanged this morning, holding the recent 10bp bounce from the lows seen last week.  European sovereign yields are higher by 1bp to 2bps across the board, with activity quiet and we’ve already discussed JGBs.  

Ironically, after Trump’s call for lower oil prices, they are firmer this morning, up 0.6%, although in the broad scheme of things, relative to the recent price action, that is tantamount to unchanged.  Here is something to consider though, which is a little bit outside the box.  The Biden EO that cited the OCSLA of 1953 prohibited drilling across a series of areas including the Atlantic and Pacific Oceans as well as the Gulf of Mexico.  Now, what is one of the first things that Trump said?  He is renaming the Gulf of Mexico to the Gulf of America.  Does that nullify the EO?  (h/t Alyosha).  I’m sure that is a legal battle to be had, but it would be right in line with Trump’s MO.  It would also allow drilling to continue unabated there, which to my understanding, has the most fruitful potential new sites.

Meanwhile, in the metals markets, they are all rallying nicely this morning with gold (+0.85%) now just about 1% below the all-time high seen in October of $2826/oz.  There are many market technicians (and gold bugs) calling for a breakout to new highs, but there is a case to be made this remains a technical short squeeze into NY delivery next week.  However, gold has dragged both silver (+0.9%) and copper (+0.9%) along for the ride.

Finally, the dollar is under pressure this morning with the DXY (-0.5%) falling to its lowest level since mid-December.  Ironically, while the G10 weakness is widespread (EUR +0.7%, GBP +0.5%, AUD +0.5%) the yen, after the rate hike, is the massive underperformer.  In the EMG bloc, one of the biggest movers is CNY (+0.5%) which is clearly benefitting from that phone call, while SGD (+0.5%) is benefitting despite the MAS having eased monetary policy.  This is an indication of just how much of a dollar selling move this is this morning.  In fact, other than the yen’s modest decline, every other major counterpart currency is higher vs. the dollar today. 

On the data front, Flash PMI (exp 49.6 Manufacturing, 56.5 Services) leads off at 9:45 then at 10:00 we see Existing Home Sales (4.19M) and Michigan Sentiment (73.2).  With the Fed meeting next Tuesday and Wednesday, there are still no speakers.  Perhaps of more interest is the fact that we have not seen a single article from the Fed whisperer lately.  As the data is third tier this morning, I wouldn’t expect anything today either.  Too, next week there is limited data of note before the meeting so unless we see a narrative shift of substance, I imagine the Fed will do nothing next week and Powell will dodge any questions regarding the future.

For now, it is all Trump and his actions, comments and EOs.  And you can’t plan how to trade those.  Once again, this is why hedging is so important.

Good luck and good weekend

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Trump’s Whirlwind

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Markets have embraced
Trump’s whirlwind. Thus, Ueda
Is free to hike rates

 

Tonight, the BOJ is apparently set to hike rates by 25bps.  The market probability is essentially 100% and the key clue is that the Nikkei news organization wrote an article about it that was published after the first day of the BOJ’s two-day meeting.  At the December BOJ meeting, Ueda-san explained that if inflation remained at or above their 2.0% target (it has) and if there were no major ructions in markets after President Trump’s inauguration (there haven’t been), then the BOJ was likely to continue to move their policy rate toward what they believe is a neutral stance.  Currently, that neutral stance is mooted at 1.00%, so a 25bp hike tonight takes the overnight rate to 0.50%, somewhat closer.

With all this widely anticipated and markets pricing in the result, the key question is how what Ueda-san will say during his press conference that follows the meeting.  There are many who are looking for a so-called ‘dovish’ hike, where there is no indication of the timing of any further rate hikes and a benign view of the future.  Certainly, a look at the FX market, where the yen (unchanged today, -0.8% in the past week) doesn’t indicate a great deal of fear over a much tighter policy.

Source: tradingeconomics.com

There has been a background narrative that explains the BOJ’s ongoing tightening is going to reach a point where Japanese investors are going to repatriate much of their overseas investment, driving a forceful upward move in the yen and having major negative impacts on risk assets around the world as liquidity retreats.  This is based on the idea that the Japanese are the largest exporters of capital in the world which is one of the key reasons equity markets are rallying everywhere, so if they bring that money home, that means they will sell their foreign equity holdings and buy yen.  While I believe this is a neatly wrapped idea, I would contend Japanese investment prospects are not yet near the same as in the US, so this idea may be premature.  In fact, a look at the chart below showing 10-year US Treasury and JGB yields overlaid with USDJPY indicates that the rate differential is nowhere near where it might need to be in order to encourage that type of behavior.  My take is absent some type of multilateral agreement to weaken the dollar, this will not happen organically.

Source: FRED database

In China, though communists rule
They favor the capital tool
Of equity bourses
And so, Xi endorses
A government stock buying pool

Elsewhere in the world, as we try to get outside the maelstrom that is Donald Trump, I couldn’t help but notice that, once again, Xi Jinping has called on his finance minions to do something, anything, to support the stock market.  And I cannot help but be struck by the irony of the Chinese Communist Party being so concerned about the situation in the most capitalistic institution of all.  The WSJ had an article discussing the latest measures that are on the board, including forcing encouraging insurance companies to increase the local equity portion of their portfolios and utilizing 30% of premium income to buy stocks.  This is on top of the PBOC reducing interest rates last year for companies that want to repurchase shares.

It continues to be very difficult for me to accept the idea that the Chinese are playing 4-D chess with long-term goals in mind while the US is playing checkers.  If that is the case, then the Chinese, or at least President Xi, is a really bad player.  His economy is under dramatic pressure because the property bubble he inflated has been shrinking for the past three years, undermining both the population’s wealth (property was their store of value) and confidence, while he ramps up more beggar thy neighbor trade policies at the same time the US has just elected a president whose middle name is Tariff.  Their population is shrinking because of the ‘foresight’ of their leadership to impose a one-child policy for two generations and while millions of people will risk their lives to immigrate to the US, people are looking to leave China.  Once again, I cannot look at this situation and conclude anything other than the CNY (-0.15%) is going to gradually decline all year long, and maybe not so gradually if pressure really builds.

Ok, let’s take a look at how markets are handling the latest set of Trumpian pronouncements and reactions by targets of his ire.  After yet another rally in the US, albeit on declining volumes so not as exciting as it might otherwise have been, Japanese shares rallied (+0.8%) as investors seem to believe that the interest rate hike tonight will be accompanied by a more dovish stance at the press conference.  Mainland Chinese shares (CSI 300 +0.2%) eked out a gain after the latest news discussed above, although Hong Kong shares (-0.4%) did not follow suit.  After all, the focus is on mainland shares.  The rest of the region was widely dispersed with gainers (Taiwan, Singapore, Philippines) and laggards (Korea, Australia, Thailand), many of these moves in excess of 1%.  It appears investors don’t know which way to turn yet given the speed of changes emanating from Washington.

In Europe, most bourses are modestly firmer (DAX +0.3%, CAC +0.5%) as we continue to hear more from ECB speakers that not only are rates going to be cut, but they are increasingly certain that they will achieve their inflation target.  Maybe they will.  As to US futures, at this hour (7:00) they are mixed to slightly softer with the NASDAQ (-0.4%) the laggard.

In the bond market, the decline in yields appears to be over, at least for now, as Treasuries (+3bps) continue to bounce from their recent lows at 4.54%.  As is almost always the case, this has carried European sovereign yields higher as well, by between 1bp and 3bps across the continent and UK and we saw JGB yields gain 1bp overnight.  I would contend there is still a great deal of uncertainty as to how the Trump administration is going to handle the conundrum of reducing inflation while expanding growth.  Outside of declining energy prices, which may be coming, it will be a tall task, and inquiring minds want to know.

Speaking of energy prices, oil (+0.35%) is edging higher after a lackluster session yesterday.  As with most markets, uncertainty is rife right now although this is clearly an area where Mr Trump is focused on expanding output.  NatGas (-0.3%) is a touch softer as forecasts for the end of the current Polar Vortex keep getting moved up. Metals markets are under some pressure this morning, with gold (-0.3%) backing away from that all-time high level and both silver and copper fading as well.  However, volumes remain light here implying not much interest overall.

Finally, the dollar is a touch stronger this morning, but there are few large movers in either the G10 or EMG blocs.  In fact, every G10 currency is within 0.2% of yesterday’s closing levels and none of them are at extremes.  The biggest loser today is ZAR (-0.6%) which seems to be responding to the precious metals complex backing off a bit overnight.  It remains very difficult to get a read on the dollar with all the other things ongoing.  As it happens, this is one market that has not received any Trumpian attention at all…yet.

We finally have a smattering of data this morning with the weekly Initial (exp 220K) and Continuing (1860K) Claims to be followed by the EIA’s oil inventory data where it appears a modest net build across products is forecast.  With the Fed quiet, and very little focus on Powell and company right now, today looks to be shaping up as another equity focused day with the dollar likely taking its cues there.  While we never know what will hit the tape these days, absent a new surprise vector, there is no reason to look for significant movement today at all.

Good luck

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Trump 2.0

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Today begins Trump 2.0
And pundits are trying to show
Their ideas are sound
As how he’ll redound
On policies he will bestow
 
But this poet can’t comprehend
How anyone thinks what they’ve penned
Is likely to be,
To any degree,
Correct. ‘Stead, let’s look at the trend

 

As Donald Trump prepares to take the oath of office today, there has been a non-stop barrage of pundits putting forth their views as to how policy proposals that were made during the campaign, and even since the election, are going to impact the economy as well as equity, bond and FX markets.  But I would take exception to all these as, if we learned nothing else from Trump’s first term in office, we have no idea how he may try to do the things he says he is going to do.  Are tariffs a funding process?  Are they negotiating tactics?  Are they punishment?  Since we have no idea at this point (all three of those ideas have been floated by “insiders” and pundits), how can we meaningfully forecast the impact tariffs may have going forward?  So, I won’t even try.

Rather, I think there is much to be learned from looking at the long-term trends in markets and perhaps trying to come up with reasons that these trends may be changing, or not, going forward.  As such, take a look at the charts below, all from tradingeconomics.com, where I have tried to highlight the long-term trend in the dollar (EURUSD), the S&P 500, 10-Year Treasury Notes, oil and gold.

My first observation is that over the past twenty-five years, oil has traded both higher and lower with no discernible direction.  Certainly, we are higher now than 25 years ago, but we have been both much higher and lower in the interim.  Now, if Trump is successful at freeing up more drilling opportunities, removing the offshore drilling ban that Biden imposed last week, and reducing the regulatory structure such that the cost of drilling declines, my take is increased supply will result in some downward pressure.  As well, if he is successful at bringing an end to the Ukraine war, it seems probable that Russian oil may no longer be sanctioned, and that, too, would pressure prices lower.  But will he impose tariffs on Canada, a key source of sour crude used to refine diesel?  That could easily pressure prices higher.  And what of Venezuela?  As I said, no way to know.  In the end, my take is that the most likely outcome is that oil will continue to demonstrate its inherent price volatility given its price inelasticity.  I think you can equally make the case for $50 oil as well as $100 oil based on many idiosyncratic issues that have nothing to do with Trump.

The only noteworthy change we have seen is in 10-Year Treasury yields, which after a 40-year downtrend following the back-to-back recessions in 1980-1982 and Fed Chair Volcker’s policy tightening, look very clearly to have reversed course.  I am not the first to notice this but believe that it is an important feature of markets going forward.  There are virtually two generations of traders and investors who have only ever seen interest rates decline and have created their mental investment models on that underlying thesis.  If the future is going to bring about higher interest rates over time (and given my view that inflation is not going to disappear and that will be a key driving force), then investment models in a higher inflation, higher yield environment are going to be different than what we have seen up through 2022.  

One of the keys is that the idea behind the 60/40 portfolio, where declines in stock prices were offset by rises in bond prices, turns out to only really be true in a low inflation environment, sub 2.5%.  If inflation is going to run at 3.5% – 4.5% going forward, then all the strategies that incorporated that 60/40 basis are going to have an awfully difficult time, again, regardless of what Trump does.  The one caveat here is if he is successful in driving inflation back to that <2.0% level, but that seems highly unlikely in the near term given how sticky inflation has proven to be even without any new policies.

Now, if we look at the dollar, that trend has been very consistent and remains in place with the dollar seemingly set to continue to appreciate.  Given Trump’s stated desire to reshore American manufacturing and reduce the trade deficit, he almost certainly would like to see the dollar decline.  However, at this point, it’s not clear what policies are going to drive that.  Historically, loose monetary and tight fiscal policy will weaken a currency, and that could well be what we see, except that is likely to create a burst of inflation before the tight fiscal policy reins that in.  And you know as well as I that Trump will be very displeased with that outcome.

It is certainly possible that the Treasury could intervene to weaken the dollar, but that is also something that is exceedingly rare in this country.  Perhaps the most likely situation here would be a Mar-a Lago (?) Accord, or something like that akin to the Plaza Accord of 1985, where the G7 at the time all agreed that the dollar needed to decline.  Now, on the one hand, given the weakness in the other G10 economies currently when compared to the US, my take is those nations are pretty happy to have weak currencies to help support their domestic industries.  On the other hand, I suspect the EMG bloc who have funded themselves in USD are really interested in seeing a weaker dollar to help them get easier access to dollars to service and repay their debt.  My take is that until there is a definitive policy pronouncement, and this will require something like that as quiet policy adjustments are likely to be missed by the FX market, this trend will remain intact.

Finally, a look at both equities and gold shows basically the same chart, with both showing accelerating price increases and both now significantly above their long-term trend lines.  The question, of course, is can this continue?  Keynes was reputed to have told us that markets can remain irrational longer than you can remain solvent, implying just because market pricing doesn’t make fundamental sense doesn’t mean it cannot continue further.  But in the end, trees don’t grow to the sky, and corrections in these markets seem somewhat overdue.  Consider the S&P 500 chart, where we see the sharp decline in 2022.  Many remember that as the worst market since the GFC crash, and yet on the chart, it looks like a modest correction.  Consider also, that if the market were to decline to the trend line I have drawn, it would be nearly a 50% correction, and that just puts it back on trend!  Again, volatility seems the watchword going forward, but until we see something that is going to change opinions, the trend in both stocks and gold seems higher.

OK, as we await the official change in presidency here, let’s review the overnight price action, which was generally positive following Friday’s US equity rally.  Remember, too, it is MLK Day, and markets are closed in the US.

Asian markets saw broad gains with the Nikkei (+1.2%) and Hang Seng (+1.75%) leading the way while mainland shares (+0.45%) lagged but were still in the green.  Away from the major markets, there were far more gainers than laggards, but the biggest moves were on the order of 0.4%, nothing of real note.  Positive Japanese data was the driver in Tokyo (Machinery Orders +3.4%) while HK and Chinese shares benefitted from the news that Presidents Trump and Xi spoke, hopefully in a prelude to less tension.  In Europe, markets are essentially unchanged across the board this morning as it seems investors cannot discern whether Mr Trump will be beneficial for the continent or not.  Certainly, I continue to read about a number of European leaders who are unhappy at the prospects of a Trump presidency (specifically PM Starmer who has ostensibly said the US-UK relationship is destined to diminish).  While that may be true, my take is it will not help the UK very much.  And, while US markets are closed today, US futures are pointing modestly higher this morning.

In the bond market, yields are edging higher in Europe, up between 1bp and 2bps on the continent while UK Gilt yields are higher by 3bps.  Overnight saw JGB yields slip 1bp and, of course, with banks closed in the US, Treasury yields are unchanged in the cash market.  However, bond futures are pointing to a 1bp rise as well.

In the commodity markets, oil is little changed on the day while NatGas (-4.4% after a -6.0% decline on Friday) is falling on news that weather models, which had been calling for another cold spell in February, have changed and are now saying temperatures will be milder then.  In the metals markets, gold (+0.3%) is edging higher while both silver (-0.3%) and copper (-0.4%) are slipping a touch, but given their inherent volatility, arguably these are unchanged on the day.

Finally, the dollar is under some pressure this morning with then euro (+0.5%) leading the G10 higher although similar sized gains are seen across the board with only JPY (0.0%) failing to go along for the ride.  EMG currencies are also picking up led by HUF (+2.0%) as it seems there is excitement in Hungary regarding the inauguration as PM Orban seems to share many of President Trump’s views on various geopolitical issues.  But CZK (+0.9%) and PLN (+0.6%) are also rallying alongside KRW (+0.5%), although MXN (-0.3%) seems to be showing concerns regarding how that relationship will evolve.  Certainly, as I mentioned above, President Trump will not be unhappy to see the dollar slide a little, but I don’t see this as the beginning of a new trend.

With no data today, and a light week in general, and given how long this missive has already become, I will lay out the data releases tomorrow.  Today, all eyes will be on the ~200 Executive Orders President Trump will sign and I expect it will take a little time to digest it all, so we will see how things really begin tomorrow.

Good luck

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Deceit

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Though many will claim it’s deceit
The Chinese declared they did meet
The target that Xi
Expected to see
Though skeptics remain on the Street
 
In fact, it appears there’s a trend
That data surprises all tend
To flatter regimes
And their stated dreams
As policy faults they defend

 

Last night, the Chinese released their monthly data barrage with final 2024 numbers as part of the mix. Despite numerous indications that Chinese growth is slowing, somehow, they managed to show a 5.4% annualized GDP growth rate for Q4 and a 5.0% GDP growth rate for all of 2024, right on President Xi’s target.  

Now, the government did add some stimulus in Q4 as they recognized things are not going well, and I continue to read articles that President Xi is starting to feel increased pressure from CCP insiders as to his stewardship of the nation and the economy.  Statistics like electricity usage and travel don’t really jive with the data, although it is certainly possible that ahead of the mooted tariffs that President Trump has threatened to impose starting next week, many companies preordered extra inventory to beat the rush, and that goosed growth.  

But there are a couple of things that continue to drag on the Chinese economy, with the primary issue the continuing implosion of the property market there.  For instance, while house price declines have been slightly slower, (only -5.3% last month) it has basically been three years since there was any gain at all as shown in the chart below.

Source: tradingeconomics.com

As well, one of the key concerns about China has been Foreign Direct Investment, which has not merely slowed down but has actually been reversing (companies leaving China) over the past two years as per the next chart.

Source: tradingeconomics.com

Meanwhile, a WSJ headline, China’s Population Fell Again Despite a Surprise Rise in Births, highlights yet another issue President Xi faces, the ongoing aging and shrinking of his nation.  Remember, GDP is basically the product of the number of people working * how much they each produce.  If that first number is shrinking, and the working age population in China is doing just that, it is awfully difficult to generate GDP growth.  Finally, I couldn’t help but notice in yesterday’s confirmation hearings for Treasury secretary, where Scott Bessent offered his view that China is actually in a recession, with massive deflation and are struggling to export their way out of the problems, rather than address their internal imbalances.  This is a theme that has been discussed widely in the past, and ostensibly, China has admitted they want to be more consumption focused in their economy, but it doesn’t appear that is the direction they are heading.

I raise these points in the context of the Chinese renminbi and how we might expect it to behave going forward.  The question of tariffs remains open at this stage, although I daresay we will learn more next week.  If they are imposed, there is a strong belief that the renminbi will weaken to offset the terms.  As it is, the currency remains within pips of its weakest level in 18 years and the trend, both short-term and for the past decade, has been for it to weaken further. 

Source tradingeconomics.com

Xi remains caught between the need for the currency to weaken to maintain competitiveness in the face of threatened tariffs from the US, and his desire to demonstrate that the renminbi is a stable store of value that other nations can trust to hold and use outside the global dollar network.  In the end, I expect the immediate competitiveness needs are going to overwhelm the long-term aspirations, especially if it is true that Xi is feeling internal pressure because of an underperforming economy.  Nothing has changed my view that we approach 8.00 by the end of the year.

Ok, and that’s really the big news overnight.  As an aside, it was interesting to watch Mr Bessent dismantle the attempts by the Democrat senators for a ‘gotcha’ moment.  As I wrote yesterday, it wasn’t really a fair fight given his intelligence, experience and understanding of markets and the economy compared to the Senators.

Let’s start in the equity world where US markets opened higher but ultimately slid all day long to close on their lows.  An uninspiring performance to say the least.  That performance weighed on much of Asia with the Nikkei (-0.3%) sliding alongside Australia, Korea and India.  On the plus side, modest gains were shown in China (Hang Seng and CSI 300 both +0.3%) and some positive numbers were seen in Taiwan, Malaysia and Singapore.  But overall, the movements were not substantial in either direction.  In Europe, though, markets are starting to anticipate more aggressive ECB rate cuts as data continues to show weakness in economic activity.  Weak UK Retail Sales data has the FTSE 100 (+1.3%) leading the way higher as hopes for a BOE cut grow.  Meanwhile, the CAC (+1.0%) and DAX (+1.0%) are both rallying on the thesis that Chinese growth is going to attract imports from both nations.  Meanwhile, US futures are higher by 0.4% at this hour (7:40).

In the bond market, all the inflation fears seem to have abated.  Either that or we continue to see a massive short squeeze and position unwinding.  But the result is yields are lower across the board with Treasury yields down 3bps further, and below 4.60% while European sovereign yields have fallen between -3bps and -5bps as investors take heart that the ECB and BOE are going to be cutting rates soon.  Perhaps the market is showing faith that Mr Bessent will be able to address the US fiscal financing crisis.  After all, he did explain in no uncertain terms that the US would not default on its debt.  But my sense is the market narrative about rising inflation and higher yields had really pushed too far, and this is simply the natural bounce back.  While this week’s inflation data was not as hot as feared, nothing has changed my view that inflation remains a problem going forward.

In the commodity markets, oil is unchanged on the day, having given back some of its substantial gains over the past two sessions, although it remains right near $79/bbl this morning.  Apparently, there are rumors Trump will end Russian oil sanctions as part of the Ukraine negotiations, but that doesn’t sound like something he would offer up initially, at least to me.  Meanwhile, NatGas (-4.0%) though slipping this morning, remains above $4/MMBtu as the US prepares for a major arctic cold snap next week.  In the metals markets, my understanding is there has been a lot of position adjustment and arbitrage between NY and London as we approach futures contract maturities, and that has been a key driver of the recent rally in metals (H/T Alyosha at Market Vibes, a very worthwhile trading Substack), but may be coming to an end in the next several sessions.  However, here, too, nothing has changed my longer-term view of higher prices over time.

Finally, the dollar is a tad stronger this morning, rallying vs. the pound (-0.4%), Aussie (-0.4%), NOK (-0.5%) and NZD (-0.5%) as all those ECB and BOE rate cut stories weigh on those currencies.  Interestingly, JPY (-0.3%) is also weaker this morning despite an article overnight signaling the BOJ will be raising rates next Friday.  On the flip side, looking at the EMG bloc, I see very modest gains by many of the key players (MXN +0.15%, ZAR +0.1%), although those moves feel far more like position adjustments than fundamentally driven changes in view.

On the data front, this morning brings Housing Starts (exp 1.32M) and Building Permits (1.46M) and then IP (0.3%) and Capacity Utilization (77.0%) later on.  There are no Fed speakers on the docket, and tomorrow is the beginning of the quiet period.  The last thing we heard from Cleveland Fed president Hammack was that inflation remains a concern and they have not yet finished the job.

For the day, I don’t think the data will have much impact.  Rather, as we are now in earnings season, I suspect that stocks will take their cues there and FX will remain in the background for now.

Good luck and good weekend

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Shortsighted

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The CPI data delighted
Investors, who in a shortsighted
Response bought the bond
Of which they’re now fond
And did so in, time, expedited
 
But does this response make much sense?
Or is it just way too intense?
I’d offer the latter
Although that may shatter
The narrative’s current pretense

 

Leading up to yesterday’s CPI data, it appeared to me that despite a better (lower) than expected set of PPI readings on Tuesday, the market was still wary about inflation and concerned that if the recent trend of stubbornly sticky CPI prints continued, the Fed would soon change their tune about further rate cuts.  Heading into the release, the median expectations were for a 0.3% rise in the headline rate and a 0.2% rise in the core rate for the month of December which translated into Y/Y numbers of 2.9%% and 3.3% respectively. At least those were the widely reported expectations based on surveys.  

However, in this day and age, the precision of those outcomes seems to be lacking, and many analysts look at the underlying indices prepared by the BLS and calculate the numbers out several more decimal places.  This is one way in which analysts can claim to be looking under the hood, and it can, at times, demonstrate that a headline number, which is rounded to the first decimal place, may misrepresent the magnitude of any change.  I would submit that is what we saw yesterday, where the headline rate rose to the expected 2.9% despite a 0.4% monthly print, but the core rate was only 3.24% higher, which rounded down to 3.2% on the report. Voila!  Suddenly we had confirmation that inflation was falling, and the Fed was right back on track to cut rates again.

Source: tradingeconomics.com

Now, I cannot look at the above chart of core CPI and take away that the rate of inflation is clearly heading back to 2% as the Fed claims to be the case.  But don’t just take my word for it.  On matters inflation I always refer to Mike Ashton (@inflation_guy) who has a better grasp on this stuff than anyone I know or read.  As he points out in his note yesterday, 3.5% is the new 2.0% and that did not change after yesterday’s data.

However, markets and investors did not see it that way and the response was impressive.  Treasury yields tumbled 13bps and took all European sovereign yields down by a similar amount, equity markets exploded higher with the NASDAQ soaring 2.5% and generally, the investment world is now in nirvana.  Growth remains robust but that pesky inflation is no longer a problem, thus the Fed can continue cutting rates to support equity prices even further.  At least that’s what the current narrative is.  

Remember all that concern over Treasury yields?  Just kidding!  Inflation is dying and Trump’s tariffs are not really a problem and… fill in your favorite rationale for remaining bullish on risk assets.  I guess this is where my skepticism comes to bear.  I do not believe yesterday’s data reset the clock on anything, at least not in the medium and long term.

Before I move on to the overnight, there is one other thesis which I read about regarding the recent (prior to yesterday) global bond market sell-off which has some elements of truth, although the timing is unclear to me.  It seems that if you look at the timing of the recent slide in bond markets, it occurred almost immediately after the fires in LA started and were realized to be out of control.  This thesis is that insurers, who initially were believed to be on the hook for $20 billion (although that has recently been raised to >$100 billion) recognized they would need cash and started selling their most liquid assets, namely Treasuries and US equities.  In fact, this thesis was focused on Japanese insurers, the three largest of which have significant exposure to California property, and how they were also selling JGB’s aggressively.  Now, the price action before yesterday was certainly consistent with that thesis, but correlation and causality are not the same thing.  If this is an important underlying driver, I would expect that there is more pressure to come on bond markets as almost certainly, most insurance companies don’t respond that quickly to claims that have not yet even been filed.

Ok, let’s see how the rest of the world responded to the end of inflation as we know it yesterday’s CPI data. Japanese equities (+0.3%) showed only a modest gain, perhaps those Japanese insurers were still out selling, or perhaps the fact that the yen (+0.3%) is continuing to grind higher has held back the Nikkei.  Hong Kong (+1.25%) stocks had a good day as did almost every other Asian market with the US inflation / Fed rate cuts story seemingly the driver.  The one market that did not participate was China (+0.1%) which managed only an anemic rally.  In Europe, the picture is mixed as the CAC (+2.0%) is roaring while the DAX (+0.2%) and IBEX (-0.4%) are both lagging as is the FTSE 100 (+0.65%).  The French are embracing the Fed story and assuming luxury goods will be back in demand although the rest of the continent is having trouble shaking off the weak overall economic data.  In the UK, GDP was released this morning at 1.0% Y/Y after just a 0.1% gain in November, slower than expected and adding pressure to the Starmer government who seems at a loss as to how to address the slowing economy.  As to US futures, at this hour (7:30) they are pointing slightly higher, about 0.2%.

In the bond market, after yesterday’s impressive rally, it is no surprise that there is consolidation across the board with Treasury yields higher by 2bps and similar gains seen across the continent.  Overnight, Asian government bond markets reacted to the Treasury rally with large gains (yield declines) across the board.  Even JGB yields fell 4bps.  The one market that didn’t move was China, where yields remain at 1.65% just above their recent historic lows.

In the commodity markets, oil (-1.0%) is backing off yesterday’s rally which saw WTI trade above $80/bbl for the first time since July as despite ongoing inventory builds in the US, and ostensibly peace in the Middle East, the market remains focused on the latest sanctions on Russia’s shadow tanker fleet and the likely inability of Russia (and Iran) to export as much as 2.5 million barrels/day going forward.  NatGas (+0.75%) remains as volatile as ever and given the polar vortex that seems set to settle over the US for the next two weeks, I expect will remain well bid.  On the metals side of things, yesterday’s rally across the board is being followed with modest gains this morning (Au +0.3%) as the barbarous relic now sits slightly above $2700/oz.

Finally, the dollar doesn’t seem to be following the correct trajectory lately as although there was a spike lower after the CPI print yesterday, it was recouped within a few hours, and we have held at that level ever since.  In fact, this morning we are seeing broader strength as the euro (-0.2%), pound (-0.4%) and AUD (-0.5%) are all leaking and we are seeing weakness in EMG (MXN -0.6%, ZAR -0.6%) as well.  My take is that the bond market, which had gotten quite short on a leveraged basis, washed out a bunch of positions yesterday and we are likely to see yields creep higher on the bigger picture supply issues going forward.  For now, this is going to continue to underpin the dollar.

On the data front, this morning opens with Retail Sales (exp 0.6%, 0.4% -ex autos) and Initial (210K) and Continuing (1870K) Claims.  We also see Philly Fed (-5.0) to round out the data.  There are no Fed speakers today, although in what cannot be a surprise, the three who spoke yesterday jumped all over the CPI print and reaffirmed their view that 2% was not only in sight, but imminent!  As well, today we hear from Scott Bessent, Trump’s pick to head the Treasury so that will be quite interesting.  In released remarks ahead of the hearings, he focused on the importance of the dollar remaining the world’s reserve currency, although did not explicitly say he would like to see it weaken as well.  The one thing I know is that he is so much smarter than every member of the Senate Finance committee, that it will be amusing to watch them try to take him down.

And that’s really it for now.  If Retail Sales are very strong, look for equities to see that as another boost in sentiment, but a weak number will just rev up the Fed cutting story.  Right now, the narrative is all is well, and risk assets are going higher.  I hope they are right; I fear they are not.

Good luck

Adf

In the “Know”

Posted on by

According to those in the “know”
It’s certain that tariffs will grow
But now some are saying
The timing is straying
From instant to something more slow

 

In what has been a generally quiet evening in the markets, the story that President-elect Trump is considering imposing all those tariffs on a gradual basis, rather than instantaneously when he is inaugurated, was taken as a bullish sign by investors.  This seems to have been the driving force behind yesterday afternoon’s modest rebound in equity markets as the current market narrative is tariffs = bad, no tariffs = good.  From what I can determine, these are anonymous comments not directly attributed to Trump or his incoming economics team and, in fact, Trump denied that possibility.

But the market impact was real as not only did equity markets rebound a bit, but the dollar, which had soared yesterday, has given back some of those gains and is modestly lower this morning.  If we learned nothing else from President Trump’s first term, it should be clear that there is frequently a great deal of bombast emanating from the White House and responding to each and every comment is a recipe for exhaustion and disaster. While this cannot be ruled out, if one were to ascribe a Trumpian gospel it would be that tariffs are beautiful so slow-rolling them doesn’t really accord with that view.  I guess we will all find out more next week.

Now, turning to data releases
This week its inflation showpieces
Today’s PPI
Is tipped to be high
While Wednesday the core rate increases

Away from that story, though, there has been little else of note overnight.  As such, let’s focus on the PPI data this morning and CPI tomorrow as they ought to help inform our views on the Fed’s actions going forward. Expectations are for headline to rise to 3.4% Y/Y while core jumps to 3.8% Y/Y.  It is difficult to look at a chart of these readings and not conclude that the bottom is in and the trend is higher.

Source: tradingeconomics.com

This is not to say that we are going to see price rises like we did back in 2022 as the waves of Covid spending washed through the economy, but the Fed’s mantra that inflation is going to head back to 2.0% over time is not obvious either.  In fact, if I were a betting man, I would estimate that we are likely to continue to see inflation run between 3.5% and 4.5% for the foreseeable future.  There is just nothing around to prevent that in the short run.  Now, if we do see significant productivity enhancements, those numbers will decline, but my take is the best opportunity for that, more effective and widespread use of AI, is still several years away.

Remember, too, that the government writ large, whether headed by R’s or D’s is all-in on inflation as it is the only opportunity they have to reduce the real value of the outstanding government debt.  Perhaps the Trump administration will take a different tack, but it is not clear they will be able to do so.  The only time inflation is a concern is when it becomes a political liability.  For the two decades leading up to Covid, it was not a daily concern of the population and central banks around the world were terrified of deflation!  In fact, there are so many comments by folks like Yellen, Bernanke and other Fed governors and presidents decrying the fact that their key regret was not getting inflation high enough, it is difficult to count them.  But as evidenced by the chart below of CPI, we no longer live in that world.

Source: tradingeconomics.com

Summing up, the current situation is that inflation has likely bottomed, the government continues to run massive fiscal deficits and given the $36 trillion in debt outstanding, the government needs to reduce the interest rate they pay on their debt.  If pressed, I would expect that we will see synthetic yield curve control (YCC) enabled by regulatory changes requiring banks and insurance companies to own a greater percentage of Treasury notes and bonds in their portfolios to ensure there is sufficient demand for issuance.  That can have the effect of turning long-term real yields negative, exactly the outcome the government wants. Remember, from 1944-1951, the Fed enacted YCC directly and it worked wonders in reducing the debt/GDP ratio.  They know this tool and will not be afraid to use it.

Ok, let’s take a look at what little action there was overnight.  After yesterday’s late rebound resulted in a mixed close with the NASDAQ still lower but the other two indices closing in the green, Asian equity markets also had a mixed picture.  The Nikkei (-1.8%) was the laggard, seemingly following last week’s US market movement after reopening from a holiday weekend.  However, Chinese shares (Hang Seng +1.8%, CSI 300 +2.6%) rallied sharply on the latest news that more Chinese stimulus was coming soon.  This time the Ministry of Commerce claimed they would be looking to boost consumption this year, but neglected to mention how they will do so.  Regardless, investors liked the story and when added to the gradual tariff story, it was all green.

European bourses are also in fine fettle this morning with gains across the board (CAC +1.2%, DAX +0.8%, IBEX +0.6%) and even the FTSE 100 (+0.1%) has managed to rally a bit.  This price movement, and that of the rest of Asia where gains were seen, seems all to be a piece with the slower tariff story discussed above.  As to US futures markets, at this hour (6:40), they are pointing modestly higher, 0.45%.

In the bond market, the only place where yields have moved significantly today is in Japan, where JGB yields have jumped 5bps and are now at their highest point since February 2011.  This followed comments from Deputy Governor Himino that the board was likely to debate a rate hike at their meeting next week and market pricing has a 60% probability priced in for the move.  There is much talk of wage increases in Japan, and Himino-san also raised questions about what the Trump administration will do and how it will impact yields.  Interestingly, despite the more hawkish rhetoric, the yen (-0.25%) actually declined today, not necessarily what you would expect.  As to the rest of the bond market, everything is within 1bp of Monday’s closing levels.

In the commodity markets, oil (-0.3%), which has been rocking lately on the increased Russia sanctions, is consolidating this morning although remains higher by nearly 6% this week and 12% in the past month. (As an aside, I don’t understand the Biden theory that sanctions driving up prices is going to be a detriment to Putin as he will make up for the loss of volume with higher prices, but then, I’m not a politician.). Meanwhile, NatGas (-3.2%) has backed off its recent highs as storage concerns ebb, although the ongoing cold weather appears to have the opportunity to push prices higher again.  As well, the latest dunkelflaute throughout Europe is driving demand for LNG.  In the metals markets, yesterday’s declines have been arrested, and we are basically unchanged this morning.

Finally, the dollar is mixed this morning, edging higher against some G10 counterparts (GBP -0.3%, JPY -0.4%) but sliding against others (NZD +0.6%).  Versus the EMG bloc, again the picture is mixed today with gainers (ZAR +0.4%, KRW +0.3%) and laggards (CZK -0.2%) although overall, I would argue the dollar is a touch softer on the back of the gradual tariff story.

On the data front, this morning’s PPI data (exp 0.3% M/M, 3.4% Y/Y) headline and (0.3% M/M, 3.8% Y/Y) core is the extent of what is to come.  Interestingly, the NFIB Index jumped to 105.1, the highest print since October 2018, as small businesses are clearly excited about the prospects of a Trump administration and the promised regulatory cuts.

Right now, both the dollar and Treasury yields are pushing to levels that have caused market problems in the past.  If these trends continue, be prepared for some more significant price action.  That could manifest as a sharp decline in equity markets, or some surprising Fed activity as they try to address any potential market structural problems that may arise.  But there is nothing due to stop the trends right now.

Good luck

Adf

Quite Clearly Concerned

Posted on by

The data on Friday exceeded
All forecasts, and has now impeded
The idea the Fed
When looking ahead
Believes further rate cuts are needed
 
Meanwhile from the Chinese we learned
Their exports are still widely yearned
But imports are falling
As growth there is stalling
And Xi is quite clearly concerned

 

Under the rubric, even a blind squirrel finds an acorn occasionally, my prognostications on Friday morning turned out to be correct as the NFP number was much stronger than expected, the Unemployment Rate fell, and signs of labor market strength were everywhere.  One of the most interesting is the number of quits rose to 13.8%, its highest level in several years and an indication that there is growing confidence amongst the labor force that jobs are available if needed.  As well, as you all are certainly aware, the market responded by selling equities and bonds while reducing the probability of Fed rate cuts this year.  In fact, this morning, the market is pricing in just 24 basis points of cuts for all of 2025, in other words, one cut only.  

Meanwhile, the bond market continues to sell off with yields rising another 2bps this morning.  the chart below shows the dichotomy between Fed funds and 10-year Treasury yields.  Historically, when the Fed was cutting or raising rates, the bond market followed.  But not this time.

Source: tradingeconomics.com

There have been many explanations put forth by analysts as to why this is the case, but to me, the most compelling is that investors disagree with the Fed’s analysis of the economy and, more specifically, with their pollyannaish tone that inflation is going to magically return to 2% because their models say so.  In fact, when looking back over the past 50-years of data, this is the only time that I can see when this dichotomy even existed.

Source: tradingeconomics.com

If I had to guess, there is going to be a lot more volatility coming as previous market signals, and more importantly, Fed market tools, no longer seem to be working as desired.  Nothing has changed my view that 10-year yields head to 5.5%, and if I am correct, look for equity markets to suffer, perhaps quite a bit.

The other story of note overnight was the Chinese trade surplus, which expanded to $104.8 billion in December which took the 2024 surplus to $1.08 trillion.  Now, much of this seems to be preordering of Chinese goods ahead of Trump’s inauguration and the promised tariffs.  But China’s surplus with other Asian economies also grew dramatically last year.  Remember, President Xi is desperate to achieve 5% growth (even on their accounting) and since the Chinese public remains unenthusiastic about spending any money given the $10 trillion hole in their collective savings accounts due to the property market collapse, Xi is reliant on exporting as much as possible.  While this is not making him any friends anywhere else in the world, it is an existential issue for him, so he doesn’t really care.  It will be very interesting to see just how the Trump-Xi relationship moves forward and what concessions are made on either side.

In the end, while the renminbi is basically unchanged this morning, it remains pegged against its 2% limit vs. the CFETS fixing onshore and is 2.35% weaker in the offshore market.  That pressure is going to continue until either the Chinese step up, apply significant stimulus to the domestic economy and start to rebalance the trade process or the PBOC lets the currency go.  Remember, too, Xi is in a tough position because he continuously explained that the renminbi is a good store of value and has been asking his trading partners to use it rather than the dollar.  But if he lets it slide, that will destroy that entire narrative, a real loss of face at the very least, and potentially a much bigger economic problem.  Interesting times.

And so, let us turn to the overnight market activity and see how things are shaping up for today and the rest of the week.  Friday’s sharp decline in US equity indices was followed by similar price action throughout Asia (Nikkei -1.05%, Hang Seng -1.0%, CSI 300 -0.3%, Australia -1.25%) as the narrative is struggling to come up with a positive spin absent further US rate cuts.  European bourses have also come under pressure (DAX -0.7%, CAC -0.8%, IBEX -0.7%, FTSE 100 -0.4%) despite the fact that ECB talking heads continue to explain that more rate cuts are coming, they just won’t be coming quite as quickly as previously expected.  At this point, the market is pricing in 84bps of cuts by the ECB this year.  And yes, US futures are also in the red at this hour (7:00), falling between -0.5% (DJIA) and -1.1% (NASDAQ).

It seems that the narrative writers are struggling to put together a bullish story right now as inflation refuses to fall while growth, at least in Europe, continues to abate.  At least, a bullish story for equities and bonds.  The dollar, on the other hand, has gained many adherents.

Turning to bonds, yields continue to climb across the board with European sovereign yields rising between 2bps (Germany) and 8bps (Greece) and everything in between.  It seems nobody wants to hold bonds right now.  The same was true overnight in Asia where the best performer was the JGB, which was unchanged, but other regional bond markets all saw yields rise between 3bps (Korea) and 9bps (Australia).  Even Chinese yields edged higher by 1bp!

In the commodity space, oil (+2.0%) is en fuego, as the impact of further sanctions on the Russian tanker fleet is being felt worldwide.  It seems the Biden administration has added another 150 Russian tankers to the sanctions list along with insurance companies, and so China and India, who have been the main recipients of Russian oil, are seeking supplies elsewhere.  As long as this continues, it appears oil has further to run.  Meanwhile NatGas (+3.8%) has blasted through $4.00/MMBtu and is now at its highest level since December 2022.  Despite all those global warming fears, the recent arctic blast has increased demand dramatically!

As to the metals markets, the story is different with gold (-0.5%) sliding alongside silver (-2.1%) and copper also trickling lower (-0.15%).  Part of this is clearly the dollar’s strength, which is impressive again today, and part is likely concern over how things are going to play out going forward between the US and China as well as the overall global economy.  Certainly, a case can be made that growth is going to be much slower going forward.

Finally, the dollar is king again, rallying sharply against the euro (-0.5%) and pound (-0.8%) with smaller gains against the rest of the G10 (JPY excepted as it rallied 0.2% on haven flows).  But we are also seeing gains against virtually all EMG currencies (CLP -0.6%, PLN -0.7%, ZAR -0.4%, INR -0.6%) as concerns grow that these other nations will not be able to ably fund their dollar debt as the dollar continues to rise.  FYI, the DXY (+0.35% to 110.07) is at its highest level since October 2022 and looking for all the world like it is going to take out the highs of that autumn at 113.20.

On the data front, this week brings CPI and PPI as well as Retail Sales.  In addition, I was mistaken, and the Fed is not in their quiet period so we will hear a lot more from them this week as well.

TuesdayNFIB Small Biz Optimism100.8
 PPI0.3% (3.4% Y/Y)
 Ex food & energy0.3% (3.7% Y/Y)
WednesdayCPI0.3% (2.8% Y/Y)
 Ex food & energy0.2% (3.3% Y/Y)
 Empire State Manufacturing4.5
 Fed’s Beige Book 
ThursdayInitial Claims214K
 Continuing Claims1870K
 Retail Sales0.5%
 Ex autos0.4%
 Philly Fed-4.0
FridayHousing Starts1.32M
 Building Permits1.46M
 IP0.3%
 Capacity Utilization76.9%

Source: tradingeconomics.com

As well, we hear from five Fed speakers over six venues.  Now, the message from the Fed has been pretty unified lately, that caution and patience are appropriate regarding any further rate cuts but that to a (wo)man they all believe that inflation is heading back down to 2.0%.  I’m not sure why that is the case because if you look at the data, it certainly has the feeling that it has bottomed, and inflation rates are turning higher as you can see from the below chart of core CPI.

Source: tradingeconomics.com

And this is before taking into account that energy prices have been soaring lately!  I realize I’m not smart enough to be an FOMC member, but they certainly seem to be willfully blind on this issue.

At any rate, certainly all things still point to a higher dollar going forward, and I imagine we are going to test some big levels soon enough (parity in the euro, 1.20 in the pound) but I am beginning to get uncomfortable as so many analysts have come around to my view.  Historically, if everybody thinks something is going to happen, typically the opposite occurs.  Remember, markets are perverse!

Good luck

Adf

Quite a Fuss

Posted on by

Inflation is still somewhat higher
Though currently nor quite on fire
Thus, further reductions
In rates may cause ructions
In markets, which we don’t desire

 

“With regard to the outlook for inflation, participants expected that inflation would continue to move toward 2 percent, although they noted that recent higher-than-expected readings on inflation, and the effects of potential changes in trade and immigration policy, suggested that the process could take longer than previously anticipated. Several observed that the disinflationary process may have stalled temporarily or noted the risk that it could. A couple of participants judged that positive sentiment in financial markets and momentum in economic activity could continue to put upward pressure on inflation.” [emphasis added]

I think this paragraph from the FOMC Minutes was the most descriptive of the evolving thought process from the committee.  Since then, we have heard every Fed speaker discuss the need for caution going forward with regard to further rate reductions although to a (wo)man, they all remain convinced that they will achieve their 2% target while still cutting rates further, just more slowly.  While today is a quasi-holiday, with the Federal government closed along with the stock exchanges, although banks and the Fed are open and making payments, I anticipate activity will be somewhat reduced.  This is especially so given tomorrow brings the NFP data which will be closely monitored given the recent strength seen in other economic indicators.  If that number is strong, I anticipate the market will reduce pricing for future rate cuts towards zero from this morning’s 40bps total for 2025.  This, my friends, will serve to underpin the dollar going forward.

In England, there is quite a fuss
As traders begin to discuss
Can Starmer and Reeves
Address what aggrieves
The nation, or are they now Truss?

The situation in the UK seems to be going from bad to worse.  Even ignoring the horrifying stories regarding the cover-up of immigrant grooming gangs and their actions with young girls, the economic and policy story is a disaster.  While the exact genesis of their fiscal issues may not be certain, the UK’s energy policy, where they have doubled down on achieving Net Zero carbon emissions and continue to remove dispatchable power from their grid, is a great place to start looking.  UK electricity prices are the highest in Europe, even higher than Germany’s, and that is destroying any ability for industry to exist, let alone thrive.  The result has been slowing growth, reduced tax receipts and a growing government budget deficit.

Some of you may remember the Gilt crisis of September/October 2022, when then PM Liz Truss proposed a mini-budget focused on growth but with unfunded aspects.  Confidence in Gilts collapsed and pension funds, who had been seeking sufficient returns during ZIRP to match their liabilities and had levered up their gilt holdings suddenly were facing massive margin calls and insolvency.  The upshot is that the BOE stepped in, bought loads of Gilts to support the price and PM Truss was booted out of office.

While the underlying issues here are somewhat different, the market response has been quite consistent with both Gilts (+5bps this morning, +34bps in past week) and the pound (-0.6% this morning, -2.0% in past week) under significant pressure again this morning.  Unlike the US, with the global reserve currency, the UK doesn’t have the ability to print as much money or borrow as much money as they would like to achieve their political goals.  In fact, the UK is far more akin to an emerging market than a G7 nation at this stage, running a massive fiscal deficit with rising inflation and a sinking currency amid slowing economic growth.  There are no good answers for the BOE to address these problems simultaneously.  Rather, they will need to address one thing (either inflation and the currency by raising rates, or economic activity by cutting them) while allowing the other problem to become worse.  

It is very difficult to view this situation as anything other than a major problem for the UK.  While it occurred before even my time in the markets, back in the 1970’s, the UK was forced to go to the IMF to borrow money to get them through a crisis.  There are some pundits saying they may need to do this again.  For some perspective, the chart below shows GBPUSD over the long-term.

Source: tradingeconomics.com

The history is the pound was fixed at $2.80 at Bretton Woods and then saw several devaluations until 1971 when Nixon closed the gold window, and Bretton Woods fell apart.  The spike lower in the 1970’s was the result of the UK policies driving them to the IMF.  The all-time lows in the pound were reached in 1985, when the dollar topped out against its G10 brethren, and that resulted in the Plaza Accord.  But since then, and in truth since the beginning, the long-term trend has been for the pound to depreciate vs. the dollar.  

It continues to be difficult for me to see a strong bull case for the pound as long as the current government seems intent on destroying the economy.  FX option markets have seen implied volatility spike sharply, with short dates rising from 8% to 13% in the past week while bids for GBP puts have also exploded higher.  Meanwhile, the gilt market cannot find a bid.  Something substantive needs to change and don’t be surprised if it is political, with Starmer or Reeves, the Chancellor of the Exchequer, finding themselves out of office and a new direction in policy.  However, until then, look for both these markets to continue lower.

I apologize for the history lesson, but I thought it best to help understand today’s price action in all things UK.  And that’s really it for discussion.  Yesterday’s mixed US session was followed by weakness in Asia (Nikkei -0.95%, Hang Seng -0.2%, CSI 300 -0.25%) with the rest of the region also lower.  However, this morning in Europe other than the DAX, which is basically unchanged, modest gains are the order of the day.  Surprisingly, the FTSE 100 (+0.55%) is leading the way higher, but given the large majority of companies in this index benefit from a weaker pound, perhaps it is not so surprising after all.

In the bond market, Treasury yields are 3bps lower this morning, although still near recent highs above 4.65%, while European sovereigns continue to rise as the global interest rate structure climbs amid growing concerns nobody is going to adequately address the ongoing inflation.  Even Chinese yields rose 2bps despite CPI data showing deflation at the factory gate continues and consumer demand remains moribund.

Commodity prices are modestly firmer this morning with oil (+0.2%) stabilizing after a sharp decline yesterday on supply concerns after a large build of product inventories in the US.  Metals prices continue to be supported (Au +0.4%, Ag +0.8%, Cu +1.2%) despite the dollar’s ongoing strength as it appears investors want to hold real stuff rather than financial assets these days.

Finally, the dollar continues to climb with most currencies sliding on the order of -0.2% aside from the pound mentioned above and the yen (+0.3%) which seems to be acting as a haven this morning.  Nonetheless, this remains a dollar focused process for now.

There is no economic data to be released today although I must note that Consumer Credit was released yesterday afternoon and fell -$7.5B, a much worse outcome than expected.  As you can see from the below chart, declining consumer credit, while not completely unheard of, is a pretty rare occurrence.  You can clearly see the Covid period and the best I can determine is the December 2015 decline is a data adjustment, not an actual decline.  The point to note, though, is that despite lots of ostensibly strong economic data, this is a warning.

Source: tradingeconomics.com

I keep looking for something to turn the tables on the dollar, but for now, it is hard to make the case that the greenback is going to suffer in any broad-based manner.  Tomorrow, though, with NFP should be quite interesting.

Good luckAdf

Falling Further

Posted on by

Like a stone toward earth
The yen keeps falling further
Beware Kato-san

 

While we have not discussed the yen much lately, its recent weakness, in concert with the dollar’s broad strength, has begun to cause some discomfort in Japan.  Last night, Japanese FinMin Katsunobu Kato explained, “We will take appropriate action if there are excessive movements in the currency market.”  He went on that he is “deeply concerned” by the recent weakness, especially moves driven by those evil pesky speculators.

The problem, of course, is that all those expectations that the BOJ would be tightening policy to fight domestic inflation while the Fed would continue to ease policy since they “beat” inflation, with the result being the yen would regain its footing, have proven to be false hope.  Instead, as you can see from the below chart, since the Fed first cut rates back in September, the yen has tumbled nearly 13% and very much looks like it is going to test the previous four-decade highs seen last summer.

Source: tradingeconomics.com

Last year, the MOF/BOJ spent about $100 billion in their efforts to stem the yen’s weakness.  They still have ample FX reserves to continue with that process, but ultimately, history has shown that maintaining a cap on a currency that is weakening for fundamental reasons is nigh on impossible.  If a weak yen is truly seen as existential in Tokyo, then Ueda-san needs to be far more aggressive in tightening monetary policy.  This is especially so given the Fed continues to back away from earlier expectations that it would be aggressively loosening policy.  Now, while JGB yields have moved higher over the past several sessions, trading now at 1.18%, which is their highest level since April 2011, that is not going to be enough to stem this tide.  From what I read, inflation is an issue, but not the same as it was in the US in 2022, so Ueda-san is not getting the same pressure to address it as Powell did back then.  My read is the BOJ remains on hold this month and hikes rates in March while the yen continues its decline.  Look for another bout of intervention when we test the 162 level, but that will not stop the rot.  Nothing has changed my view of 170 or higher in USDJPY by year end.

Though Treasury yields have been rising
Most credit spreads have been downsizing
So, corporate supply
Is ever so high
An outcome that’s somewhat surprising

In the bond market, government bond yields continue to rise around the world (China excepted) as investors increase their demands in order to hold the never-ending supply of new bonds.  Ironically, despite this ongoing rout in government bonds across the board, corporate debt issuance looks as though it will set new records this month.  One thing to remember here is that corporates have a lot of debt coming due over the next two years as all that issuance during the ZIRP period needs to be rolled over.  But the other thing to recognize is that corporate credit spreads, the amount of yield investors require to own risky corporate bonds vis-à-vis “safe” government bonds, has fallen to its lowest levels in years, and as can be seen in the chart below, the extra yield available for high-yield investors is shrinking faster than for investment grades.

Potentially, one reason for this is the dramatic increase in the amount of Private Credit, the latest investment fad where weaker credits go directly to funds designed to lend money rather than to their banks, and investors ostensibly remove one of the middlemen from the process.  As such, there is less of this debt around than there otherwise might be, hence increasing demand and reducing that credit spread.  But the other reason is that there continues to be a significant amount of investable assets looking for a home, and with global yields near the highest they have been in a decade or more, and with the equity market dividend yield down to just 1.27% or so, a record low, there are lots of investors who are comfortable with clipping 5% or 5.5% coupons on BBB corporate bonds.

The question I would ask is, if government bond yields continue to climb, and I see no reason for that to stop given the trend in inflation and necessary issuance, at what point are investors going to get scared?  We are likely still a long way from that point, but beware if the new Treasury Secretary, Scott Bessent, follows through with his hinted views of reducing T-bill issuance and increasing coupon issuance, yields could go much higher absent the Fed implementing QE.  That would cause some serious market ructions!

Ok, let’s see how things look around markets this morning after yesterday’s sell-off in the US equity markets.  It seems Japanese stocks were caught between the weaker yen (generally a stock positive) and the tech sell-off (generally a stock negative) with the Nikkei closing lower by -0.25% on the session.  Meanwhile, the Hang Seng (-0.9%) suffered a bit more on the tech move, although Mainland shares (-0.2%) were not as badly affected.  An interesting story here is that the chief economist at state-owned SDIC Securities made comments at an international forum run by the Peterson Institute that really pissed off President Xi.  Gao Shanwen said the quiet part out loud when he claimed that actual GDP growth in China for the past several years has likely been much closer to 2% than the 5% published.  That story has been widespread in the West, although has never been given official credence.  And for Xi, 2% growth is not going to get it done, what with the property bubble still imploding and consumption declining despite promises of more stimulus.  Stay tuned to this story to see if we start to see more Western analysts reduce their expectations.  Elsewhere in Asia, the picture was mixed with gainers (Korea, Australia, Singapore) and laggards (Taiwan, Malaysia, Philippines).

In Europe, red is today’s color, led by the CAC (-1.0%) although we are seeing losses across the board. Eurozone data showed declining Consumer Confidence, Economic Sentiment and Industrial Sentiment all while inflation expectations remain stubbornly high.  That stagflationary hint is typically not an equity market benefit so these declines should be expected.  The story on the continent is not a positive one and I maintain that the ECB is going to have to cut rates more aggressively than their inflation mandate would suggest.  That might support equities a bit, but it will be hell on the euro!  Finally, US futures are a touch softer (-0.2%) at this hour (7:05) although they were higher most of the overnight session before this.

As mentioned above, bond yields are higher with Gilts (+9bps) leading the way as not only is the economy suffering from some very poor policy decisions by the Starmer government, but it seems that the ongoing political crisis regarding grooming gangs has investors shying away.  But yields continue to rise across the board with continental yields up between 3bps and 6bps, Treasury yields higher by another 1bp this morning after a 10bp rise in the previous two sessions, and JGB yields, as mentioned, higher by 5bps.  This trend is very clear!

In the commodity markets, oil (+0.5%) keeps on keeping on, as API data showed a greater than 4mm barrel draw on inventories, far more than expected and indicating a reduced supply around.  Cold temperatures are keeping NatGas (+5.0%) firm as well.  In the metals markets, both precious and base are under a touch of pressure this morning, down less than -0.2%, largely in response to the dollar’s rebound.

Speaking of the dollar, it is higher against all its counterparts this morning with the pound (-1.2%) the G10 laggard although weakness on the order of 0.5% is pretty common this morning.  In the EMG bloc, ZAR (-1.5%) is the worst performer, after weaker than expected PMI data called into question the economic path forward.  But here, too, we are seeing weakness like MXN (-0.9%), CLP (-0.8%), PLN (-0.8%) and KRW (-0.5%).  I would be remiss to ignore CNY (-0.25%), which is trading below (dollar above) 7.3600 in the offshore market, and is now 2.4% weaker than last night’s fixing rate.  This is also the weakest the renminbi has been since it touched this level back in September and then November 2007 prior to that.  Those Chinese problems are coming home to roost for President Xi.

On the data front, ADP Employment (exp 140K) leads the day followed by Initial (218K) and Continuing (1870K) Claims.  These are being released this morning because of tomorrow’s quasi holiday regarding the late President Carter, when US markets will be closed.  This afternoon, the FOMC Minutes arrive and will be scrutinized closely to see just how hawkish they have become.  We also hear from Governor Waller this morning with caution being the watchword from virtually every Fed speaker of late.

It is all playing out like I anticipated, with the ISM data showing strength yesterday, not just in the headline number, but also in the Prices Paid number.  The Fed will have no chance to cut rates again, and I look for the dollar to continue to rise.

Good luck

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Active De-Bonding

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Up north is a nation quite vast
Whose money, of late’s been, out, cast
But word that Trudeau
Is soon set to go
Has seen Loonies quickly amassed
 

One of the biggest stories over the weekend has been the sudden upsurge in articles and discussion regarding the remaining tenure for Canadian PM Justin Trudeau.  For the past several weeks, since his FinMin Krystia Freeland resigned and published a scathing resignation letter, pressure on Trudeau has increased dramatically.  It appears that it is coming to a head with articles from both Canadian and international sources indicating he may step down as soon as this week.  As well, his main political rival, conservative party leader Pierre Poilievre, is touted, according to the betting websites, as an 89% probability to be the next PM.
 
Now, we all know the dollar has been strong in its own right lately, and I suspect that while there will be bumps along the road, it will get stronger still over the year absent some major Fed rate cutting.  As such, USDCAD is higher along with everything else.  However, you can see in the chart below (the green line rising faster than the blue line since December) that it has been an underperformer for the past month, since that Freeland resignation, as investors have been shying away from Canada, given the combination of concerns over the incoming Trump administration imposing tariffs and no political leadership to address these issues.

 

Source: tradingeconomics.com

While no sitting politician is ever willing to cede power easily, and there are indications that Trudeau is going to go down kicking and screaming, ultimately, I expect that Poilievre will be the PM and will develop a strong relationship with the US.  As that becomes clearer, I expect to see the CAD appreciate modestly vs. the dollar, but much more so against other G10 currencies.

Once more, what the Chinese have said
Is stimulus is straight ahead
But so far, its talk
They ain’t walked the walk
So, bulls need take care where they tread

Another tidbit this morning comes from Beijing, where the economic planning agency there has indicated that they will expand subsidies for consumer purchases of electronic goods like cellphones, tablets and smart watches, as President Xi continues to watch his nation’s economy grind along far more slowly than he really needs to happen.  There was an excellent thread on X this morning by Michael Pettis, one of the best China analysts around, describing the fundamental problem that Xi has and why the slow motion collapse of the property market portends weakness for a long time going forward.  As is almost always the case, while tearing the proverbial band aid off quickly can hurt more at the instant, the pain dissipates more quickly.  President Xi believes he cannot afford to inflict that much pain, so their problems, which stem from decades of malinvestment in property that inflated a massive bubble, are going to last for a long time.  While CNY (+0.4%) is modestly firmer this morning, that is only because the dollar is weaker across the board, and in fact, it is significantly underperforming.

This week, the US Treasury’s Yellen
Much debt, will look forward to sellin’
The market’s responding
By active “de-bonding”
With dollars and bonds both rebellin’

The last big story of the day is clearly the upcoming Treasury auctions this week, where the US is set to sell $119 billion of debt, starting with $58 billions of 3-year notes today.  Arguably, market participants have been aware that this was going to be a necessary outcome given the massive deficits that continue to be run by the US.  Adding to the broad concept of deficits, the Biden administration appears to be trying to spend every appropriated dollar in the last two weeks in office and that requires actual cash, hence the auctions to raise that cash.  In addition, the debt ceiling comes back into force shortly, so they want to get this done before that serves to prevent further issuance.

Now, the yield curve has reverted back to a normal slope with the 2yr-10-yr spread at 34bps and 30yr bonds trading another 22bps higher than 10yr at 4.81% and bringing 5% into view.  Here’s the thing about the relationship between the dollar and yields; the dollar is typically far more correlated to short-term yield differentials, not long-term yields.  So rising 30yr bond yields is not likely to be a dollar benefit.  In fact, just the opposite as international investors will not want to suffer the pain of those bonds declining in price rapidly.  

And this is what we are witnessing this morning as the dollar, which rallied sharply at the end of last week, is correcting in a hurry today.  As mentioned above, CNY is the laggard with the euro, pound, Aussie, Kiwi and Loonie all firmer by 1% or more this morning and similar gains seen across the emerging markets, with some extending those gains as far as 1.35% or so.  Is this the end of the dollar?  I would argue absolutely not.  However, that doesn’t mean that we won’t see a further decline in the buck before it heads higher again.  A quick look at the chart below, which shows the Dollar Index, while it has just touched the steep trend line higher, it remains far above its 50-day and 100-day moving averages.  Howe er, it seems that the big story here comes from a report from the Washington Post that Trump is considering much less widespread tariff impositions with only some critical imports to be addressed.  As such, given the tariffs = higher dollar consensus, if this is true, you can understand the dollar’s retreat.

Source: tradingeconomics.com

However, today’s story is that of a weak dollar and strong equity markets, well at least in some places. Friday’s US equity rally was not followed by similar enthusiasm in Asia with the Nikkei (-1.5%) leading the way lower while both the Hang Seng (-0.4%) and China (-0.2%) also lagged.  Perhaps the mooted China stimulus helped those markets on a relative basis.  Europe, however, is in fine fettle (CAC +2.3%, DAX +1.4%, IBEX +0.9%) as PMI data released this morning was solid, if not spectacular, and the weaker dollar seems to be having a net positive impact.  US futures are also firmer, with NASDAQ (+1.1%) leading the way.

In the bond market, the big movement was in Asia overnight as JGBs (+4bps) sold off alongside virtually every other Asian bond market except China, which saw yields edge lower by 1bp to a new record low of 1.59%.  In Europe, there has been very little movement with yields +/- 1bp at most and Treasury yields, which had been firmer earlier in the overnight session, have actually slipped back at this hour and are lower by 2bps to 4.58%.

In the commodity markets, the weak dollar has helped support prices here with oil (+1.0%) continuing its rally (+9% in the past month) as the combination of Chinese stimulus hopes and cold weather seem to be providing support.  Speaking of cold weather, NatGas (+7.4%) is also in demand this morning as winter storm Barrie makes its way across the country.  In the metals markets, gold (+0.3%) is the laggard this morning with both silver (+2.3%) and copper (+2.4%) really taking advantage of the dollar’s weakness.

On the data front, there is a ton of stuff this week, culminating in NFP on Friday.

TodayPMI Services58.5
 PMI composite56.6
 Factory Orders-0.3%
TuesdayTrade Balance-$78.0B
 ISM Services53.0
 JOLTS Job Openings7.70M
WednesdayADP Employment139K
 Initial Claims217K
 Continuing Claims1848K
 Consumer Credit$12.0B
 FOMC Minutes 
FridayNonfarm Payrolls160K
 Private Payrolls134K
 Manufacturing Payrolls10K
 Unemployment Rate4.2%
 Average Hourly Earnings0.3% (4.0% Y/Y0
 Average Weekly Hours34.3
 Participation Rate62.8%
 Michigan Sentiment73.9

Source: tradingeconomics.com

In addition to all this, we hear from six more Fed speakers over seven venues with Governor Waller likely the most impactful.  Over the weekend, we heard from Governor Kugler and SF President Daly, both explaining that they needed to see more progress on inflation before becoming comfortable that things were ok.

Clearly, the tariff story is the current market driver in the dollar.  As I never saw tariffs as the medium-term driver of dollar strength, I don’t think it has as much importance.  Plus, this is a report from the Washington Post.  There are still two weeks before inauguration and many things can happen between now and then.  Nothing has changed my longer-term view that the dollar will be supported as the Fed, which is not tipped to cut rates this month and is seen only to be cutting about 40bps all year will ultimately raise rates as inflation proves far more stubborn than desired.  But that is the future.  Today, pick spots to establish dollar buys and leave orders.

Good luck

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