Tag Archives: #Japan

Not Even a Token

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Like spring rains falling
So too, Japanese prices
Continue to slide

 

Once upon a time there was a tiny thought about Japan tightening monetary policy.  This thought, which had been seen lurking in the shadows of markets for the past thirty years, was largely ignored by all the ‘right’ people.  The illiterati economic gliteratti were all quite convinced that this would never happen as Japan was in a death spiral of rising debt and a shrinking population.  According to all the classical economic texts, interest rates could never rise again.

Then, one day there came along a virus that disrupted the world.  All the ‘important’ people in all the major nations determined that shutting down all economic activity while simultaneously printing trillions upon trillions of dollars, euros, pounds, and yen, and more importantly, giving that money to the people, was the best thing to do.  Not that surprisingly, with all that extra money chasing after fewer available goods and services, prices rose sharply almost everywhere.  Even in Japan, a nation that had suffered a generation-long deflationary bout, where companies literally apologized if they determined that a price rise was in order to cover rising expenses, prices started to go up more broadly.

This excited the policymakers in Japan as it was something they had been trying to achieve for the past 30 years.  It also excited the trading community as they became convinced that Japanese interest rates were set to explode higher.  And for a little while, Japanese inflation rates rose, surpassing the 2.0% target that had only been briefly brushed three times during that generation, the most recent being in the wake of the Covid actions.  Analysts were convinced that the new BOJ Governor, Kazuo Ueda, was getting set to raise the policy rate from its current level of -0.10%, its home for the past 8 years.  Traders positioned for JGB yields to rise and for the yen to strengthen against its currency counterparts.

Alas, so far this tale has not had that happy ending.  Instead, last night CPI in Japan printed at 2.2% headline, 2.0% core with both measures clearly trending lower for the past 18 months at least.  To be clear, in the very short term, these prints were marginally higher than market forecasts, which has resulted in a touch of strength in the yen (+0.3%), and a 1bp rise in 10-year JGB yields.  But bigger picture, this has further called into question the idea that Japanese inflation is going to remain stable at the BOJ’s 2% target.  In this situation, the idea the BOJ will tighten policy seems increasingly remote.  As such, all those delusions of tight money have been, once again, laid to rest.  The moral of this story is that; in Japan, the only money is easy money!

The newest Fed member has spoken
And Schmid said that things just ain’t broken
Thus, patience is needed
And so, he conceded
No rate cuts, not even a token
 
The Kansas City Fed’s new president, Jeffrey Schmid, made his first public comments yesterday but it could well have been his predecessor, uber-hawk Esther George, given that he hewed to the party line as follows:, “With inflation running above target, labor markets tight, and demand showing considerable momentum, my own view is that there is no need to preemptively adjust the stance of policy.  I believe that the best course of action is to be patient, continue to watch how the economy responds to the policy tightening that has occurred, and wait for convincing evidence that the inflation fight has been won.”  That’s pretty clear, and while he is not a current voter, it is simply another voice telling us that the Fed is not anxious to alter policy at all.  Even the market gets it now, with the March meeting down to a 0.5% probability of a cut, the May meeting down to a 16.3% probability and even the June meeting down to a 60% probability.  For all of 2024, the market is now pricing in just 3 ½ cuts, pretty darn close to the last dot plot.  Kudos to the Fed for getting their message across.
 
However, beyond those two stories, there is precious little to discuss this morning.  Data, beyond the Japanese CPI, has been sparse and the ECB speakers have also stayed true to their recent mantra of no reason to cut rates yet.  As such, it is not that surprising that markets remain mired in tight ranges overall.
 
Looking first at equity markets, after a lackluster session in the US yesterday, Japanese share prices were essentially unchanged although we did see some strength in Chinese shares with both the Hang Seng (+0.9%) and CSI 300 (+1.2%) rallying nicely on the back of increasing hopes for more Chinese stimulus coming in March at the annual plenary sessions.  As to the rest of Asia, activity was mixed with some countries seeing gains (India, Australia) and some losses (South Korea and Taiwan).  European bourses are also mixed with some gainers (Germany) and losers (Spain) while others have gone nowhere at all.  Finally, at this hour (6:45), US futures are ever so slightly firmer, just 0.1%.
 
In the bond market, both Treasuries and European sovereigns are seeing a bit of buying with yields lower by 1bp across the board.  Yesterday’s US 5-year auction was also somewhat unloved with a 0.8bp tail, quite large for that maturity.  It does appear that there is increasing pressure on the Treasury market as the pace of issuance picks up.  Over time, I believe this is going to matter a lot more to markets than it has thus far.
 
Oil prices, which rallied most of yesterday, are giving back some of those gains, down -0.4% this morning.  The rally was ostensibly based on further Red Sea concerns, but that really doesn’t make much sense given there were no new events there.  More likely, there was some short covering and analysts were looking for a story to tell.  Metals markets, though are in better shape this morning with gains in both precious (gold +0.3%) and base (copper +0.2%, aluminum +1.0%), largely on the back of the dollar’s modest weakness.
 
Which brings us to the dollar and the most confusing part of the session.  While it is true Treasury yields are lower by 1bp, that does not seem enough to weigh on the dollar, especially given the universal nature of yield declines.  The US curve actually inverted further, with the 2yr-10yr spread back to 42bps (it had been hanging around 25bps-30bps for several months), so that could be weighing on the greenback.  But whatever the cause, we are seeing pretty uniform weakness, although other than ZAR (+0.75%) which has clearly been helped by the metals rally, the rest of the movement is pretty modest, +/- 0.2% or less with more currencies gaining than losing.  I do not believe that the reaction function has changed here.  Rather, sometimes the FX market moves in funny ways.
 
On the data front, this morning brings Durable Goods (exp -4.5%, +0.2% ex transport) and Case-Shiller Home Prices (6.0%).  Yesterday saw a softer than expected New Home Sales and a weaker than expected Dallas Fed survey, although it was better than January’s print.  As well, we hear from Vice Chairman Barr, but there has been very little wavering from the message that patience is a virtue, and I don’t expect Mr Barr will change that tune.
 
The equity bulls took a rest yesterday but are clearly looking for more reasons to get back to buying.  To me, the potential problem will be home prices as, if they continue to rise, it will reduce hopes for any rate cuts at all, and there are still a number of pockets in the economy that are highly reliant on low interest rates to succeed.  Commercial real estate is simply the most frequently discussed, but consider much of the tech sector, where ideas that had been funded with free money that will not get the time of day if there is a cost of capital.  Ultimately, nothing has changed my idea of the dollar benefitting further as the market continues to understand that the Fed is not set to cut rates any time soon.  Of course, Thursday’s Core PCE could change a lot of views, mine included.
 
Good luck
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Growth Will, Fall, Free

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In China when data is weak
And nothing implies there’s a peak
The answer is to
Remove it from view
And henceforth, no more of it speak

But just because President Xi
Decided there’s nothing to see
That will not prevent
The wid’ning extent
Of views China’s growth will, fall, free

Last night China released their monthly series of economic statistics, all of which were lousy.  Briefly, Retail Sales (2.5%), IP (3.7%), Fixed Asset Investment (3.4%), Property Investment (-8.5%) and Unemployment (5.3%) all missed the mark with respect to economists’ forecasts and all indicated much weaker growth than previously expected.  Conspicuously there was one data point that was missing, youth unemployment, which had been rising rapidly over the past months and in June reached a record high of 21.3%.  However, given the amount of negative press coverage that particular data point was receiving, especially in the West, it seems that President Xi decided it was no longer relevant and it will not be published going forward.  Given the broad-based weakness in all the other data, as well as the fact that there are many new graduates who would have just entered the workforce, one can only assume the number was pretty substantially higher than 21.3%.

The other news from China was that the PBOC cut their 1yr Medium-Term Lending Facility rate by 15bps in a complete surprise to the market.  As well, the 1wk repo rate was also cut by 10bps as the government there tries to address the very evident weakening economic picture without blanket fiscal stimulus.  One cannot be surprised that the renminbi weakened further, falling another -0.4% onshore with the offshore version currently -0.5% on the session.  One also cannot be surprised that Chinese equity markets were all under pressure as prospects for near-term growth continue to erode.  FYI, the renminbi is within pips of its weakest point in more than 15 years and, quite frankly, there is no indication it is going to stop sliding anytime soon.  I continue to look for 7.50 before things really slow down.

As growth increases
And inflation remains high
Can QE remain?

In contrast to the Chinese economic data, we also saw Japanese data overnight and it was a completely different story.  Q2 GDP was estimated at 6.0% on an annual basis, much higher than expected and an indication that Japan is finally benefitting from its policy stance.  While inflation data will not be released until Thursday, the current forecasts are for little change from last month’s readings.  However, remember every inflation indicator in Japan is above the BOJ’s 2% target so the question remains at what point is QE going to end?  For the FX market this matters a great deal as USDJPY is back above 145 again, and if you recall the activities last October, when USDJPY spiked above 150 briefly and the BOJ/MOF felt forced to respond with significant intervention, we could be headed for some more fireworks.  However, despite the BOJ’s YCC policy adjustment at the last BOJ meeting in July, the JGB market has remained fairly well-behaved, so it doesn’t appear there is great internal pressure to do anything yet.  The flipside of that is the US treasury market, where 10yr yields are back above 4.20% and that spread to JGBs keeps widening.  As the Bloomberg chart below demonstrates, the relationship between 10yr Treasury yields and USDJPY remains pretty tight.  Given there is no indication 10yr yields are peaking, I suspect USDJPY has further to rise.

All this, and we haven’t even touched on Europe or the UK, where UK employment data showed higher wages and a higher Unemployment Rate, a somewhat incongruous outcome.  The Gilt market has sold off on the news, with yields climbing about 6bps, but the rest of the European sovereign market is much worse off, with yields rising between 8bps and 12bps.  Treasuries are the veritable winner with yields this morning only higher by 3.5bps.

What about equities, you may ask, after yesterday’s positive US performance.  The disconnect between the NASDAQ’s ongoing strength in the face of rising US yields remains confusing to many, this poet included, as the NASDAQ, with all its tech led growth names, seems to be an extremely long duration asset.  But, another 1% rally was seen yesterday, ostensibly on the strength of Nvidia which rallied after a number of analysts raised their price target on the company amid news that Saudi Arabia and the UAE both have been buying up the fastest processors the company makes.  Well, while Japanese equities managed gains after the strong data, all of Europe is in the red, all by more than 1% and US futures are currently (7:30) lower by about -0.5%.  If US yields continue to rise, and there is no indication they are going to stop doing so in the near future, I find it harder and harder to see equity prices continue to rise as well.  Something’s gotta give.

Interestingly, the commodity space seems to be out of step with the securities markets.  Or perhaps not.  Oil (-1.0%) is down for the third day in four, hardly the sign of economic strength, as arguably the combination of rising interest rates and slowing growth in China would seem to weigh on demand.  And yet, the soft-landing narrative remains the highest conviction case among so many analysts.  So, which is it?  Soft landing with continued growth and energy demand?  Or a hard landing with energy demand falling sharply?  My money is on a harder landing, although I think energy demand will surprise on the high side regardless.  Meanwhile, both base and precious metals are under pressure today with copper (-1.6%) the laggard of the group.  Remarkably, despite ongoing USD strength, gold is still above $1900/oz, but at this point, just barely.

Speaking of the dollar, today is a perfect indication of why the dollar index (DXY) is not a very good estimator of the overall trend.  As I type, DXY is lower by about -0.2%, yet the dollar has risen against virtually every APAC currency and the entire commodity bloc in the G10.  In fact, the only currencies rising today are the euro and pound, both higher by about 0.2%.  At any rate, there is no indication that the dollar’s rebound is ending either.  This is especially true for as long as US yields continue to climb.  Think of it this way, global investors need to buy dollars in order to buy the high yielding Treasuries we now have, so demand is likely to remain robust for now.  

On the data front, Retail Sales (exp 0.4%, 0.4% ex autos) is the big number but we also see Empire Manufacturing (-1.0) and the Import and Export Price Indices.  In addition, we hear from Minneapolis Fed President Kashkari at 11:00, which is likely to have taken on more importance now that we have seen the first split on the concept of higher for longer.  Which camp will he fall into and how vocal will he be regarding the potential to cut rates next year?

But, putting it all together right now, risk is under pressure, and I see no reason for that to change today.  I guess a blowout Retail Sales number, something like 1.0% could get the bulls juices flowing, but that would likely push yields even higher and that is going to be a drag.  Either way, I like the dollar to continue to perform well here overall, especially against EMG currencies.

Good luck

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Jay Will Scrape By

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Today it’s about CPI
As Jay and his cadre still try
To push prices lower
Which might mean growth’s slower
But don’t worry, Jay will scrape by

This morning we see the last big data point before the Fed meets in two weeks’ time as CPI is to be released at 8:30am.  According to Bloomberg’s survey, the median expectation is for both headline and core monthly prints of 0.3% with the Y/Y numbers at 3.1% headline and 5.0% core as a result.  There are many who are excited about the prospect of a 2 handle on the headline number as a potential catalyst for the equity market to break out even higher. The idea seems to be that a reading that low will get the Fed to change their tune and not merely stop raising rates but start bringing rate cuts back on the table.  Wishful thinking in my view, but that’s what makes markets.

Even a cursory analysis of the commentary from the plethora of Fed speakers we have heard since the last meeting shows that there is very little willingness to end the current tightening program anytime soon.  Certainly, there is no indication that a cut is even remotely a consideration.  But equity bulls need a story to push their thesis, so there you have it.  The thing is that while this month is clearly going to show a substantial decline on a year over year basis due to the base effects (remember, June 2022 M/M CPI was +1.2%, the peak), next month has the opposite base effect with the July 2022 M/M reading at 0.0%.

As I’m sure all of you are very clearly aware, there is essentially no evidence in our day-to-day llives that indicates prices are declining across the board.  While gasoline prices have certainly fallen from their highs, they appear to have bottomed along with oil, and if you head out to a restaurant, especially one that you frequent, I’m sure you’ve seen the same steady rise in prices that I have.  Remember, too, that CPI measures the change in prices on a monthly or annual basis, not the level of prices.  Absent deflation, something that is incredibly unlikely in the current monetary and fiscal framework, prices are never going back to where they were prior to the pandemic.  I sincerely hope wages continue to rise for all our sakes.

In the end, I continue to look at the employment situation as the critical variable for the Fed as weakness there will be the only thing that deters them from continuing their current mission.  Powell clearly believes that the Silicon Valley Bank situation has been completely contained and that there will be no further concerns to distract them going forward.  Maybe that is correct, but I am wary of accepting the idea that the fastest rate hikes in the Fed’s history are consistent with minimal damage to the economy.  My suspicion is that there will be far more coming, it’s just that refinancings have not been necessary yet.  When companies on the margin need to pay 9% to refinance their 4% coupon, it will result in an even greater uptick in bankruptcies than we have already seen this year and according to Epiq Bankruptcy, a compiler of bankruptcy information, filings have jumped by 68% this year compared to last, with a total of 2,973 in the first six months of the year.  If the Fed continues to tighten, look for this number to rise further, and possibly faster.  

Ahead of the data, the bulls remain in charge of the market with yesterday’s rally having been followed throughout Europe this morning although last night’s Asia session was more mixed.  In fact, one of the best performing markets of the year, Japan, has seen something of a reversal in the past two weeks as the Nikkei has fallen almost 11% while the yen has rallied about 3.5%.  This is no coincidence as much of Japan’s corporate profitability continues to rely on exports and the yen’s recent strength (+0.5% today with the dollar back below 140 again) has clearly been a weight around that market’s neck.  Interestingly, despite the same mercantilist mindset in China, the relation between the Chinese stock market and the renminbi is far less tight.  As it happens, CNY (+0.2%) is a bit firmer this morning but is less than 1% from its bottom while the Chinese stock market continues to flounder, having fallen yet again last night and continuing its downtrend for the year.

Turning to the bond market, 10-year yields have slipped another 2.5bps this morning as for now it appears the market is rejecting that 4.0% level.  Of more interest is the fact that the 2yr yield has fallen faster with the curve inversion down to -90bps.  This is an indication that bond investors are entertaining the idea that inflation is slowing, and the Fed will back off.  Be careful if there is a high CPI print today as that will almost certainly see quite the reversal of this price action.  Regarding the rest of the world, European sovereigns are following Treasuries with yields generally slipping between 2bps and 3bps, but the real surprise is Japan, where yields rose 1.9bps last night and are now at 0.467%, quite close to the YCC cap for the first time in Ueda-san’s tenure.  The combination of rising JGB yields and a stronger yen has a lot of tongues wagging that a policy change is in the offing in Tokyo.  It strikes me that Ueda-san is far more likely to move when the market is not expecting something rather than being seen to respond to pressure from the market.  However, anything is possible there.

WTI is back above $75/bbl this morning for the first time in two months and there are many, this pundit included, who believe that we may have seen the bottom.  Fundamentals like the Saudi production cuts and the Biden administration discussion of refilling the SPR are adding support, as is the fact that while recession continues to be forecast, it has not yet seemed to arrive.  Do not be surprised if we see $80/bbl or higher before the summer is over.  As to metals prices, gold is marginally higher this morning, benefitting from the dollar’s continuing weakness, as are both copper and aluminum.

Finally, talking about the dollar’s weakness, it is widespread with NOK (+0.65%) rallying alongside oil and SEK (+0.5%) also benefitting from commodity prices.  The only G10 laggard is NZD (-0.2%) which seems to have been disappointed that the RBNZ left rates on hold last night.  Speaking of central banks, this morning we hear from the BOC which is expected to raise rates again by 25bps to 5.0% at 10:00am so be attuned for any alternative outcome.

As to the emerging markets, it is a story of modest strength across almost the entire set with no real outstanding stories to highlight.

In addition to CPI, we also get the Fed’s Beige Book this afternoon and we hear from four more Fed speakers starting with Richmond’s Thomas Barkin right when CPI is released.  The only thing that might be interesting is if somebody starts to change the tune, something that I find highly unlikely at this time.

We will have to see the print to have any chance of understanding the next steps, but for now, the dollar is on its heels and absent a strong print, seems likely to test its recent lows before anything else.

Good luck

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Not the Plan

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It turns out the internet can
Stop working, though that’s not the plan
Thus, to be succinct
The people who linked
Their lives to it found nothing ran

Under the heading, ‘It’s amusing today but could be much worse’, it seems there is a downside to all the conveniences we were promised if we just linked all the mundane features of life to the internet so the IoT could work its magic.  When the IoT stops working, so do all those mundane features, like door locks using Ring, and Roomba® vacuums and smart refrigerators and washing machines.  And so, yesterday, when Amazon Web Services crashed for upwards of 9 hours along the East Coast, many people and businesses learned just how reliant they were on a single private company (albeit a big one) for maintaining the status quo of their lives.  Do not be surprised if the question arises as to whether the ‘cloud’ has become too important for the private sector to manage by itself and needs to be regulated as a utility going forward.

With omicron somewhat less feared
The bulls feel the way has been cleared
To add to positions
Which led to conditions
Where price rises were engineered

Markets, however, were completely unconcerned with any hiccups regarding the cloud and bulled ahead with spectacular gains yesterday as the NASDAQ led the way rising more than 3.0%.  While this author’s view is risk appetite is more closely correlated to views on / concerns over the tapering of QE and tighter Fed policy, the narrative has been very focused on omicron and the news that it seems to be more widespread but far less virulent and therefore will have a lesser impact on the recovering economy.  At least, that’s what the punditry is saying this morning as an explanation for yesterday’s massive risk-on rally.

And perhaps, that is an accurate viewpoint.  Perhaps last week’s selloff was entirely due to the uncertainty over just how impactful omicron would be on the global economy.  The problem is that doesn’t pass the smell test.  Consider that if omicron was really going to result in another wave of economic closures, the central bank response would likely be adding still more liquidity to the global system, much of which would find its way into equities.  In contrast, tighter monetary policy that reduces overall liquidity would have the opposite effect.  As such, it seems to me that sharp declines are more likely on fear of less liquidity than fear of the latest virus variant.  So, while markets are still pricing rate hikes for next year, they have clearly come to grips with the current expected pace of those hikes.  Now, if inflation continues to rip higher, and we see the latest CPI print on Friday, the sanguinity over the pace of rate hikes could well disappear.  Remember that there are many ‘fingers of instability’ weaving throughout the market construct, among them massive leverage and extremely high equity valuations.  Risk is a funny thing, it often isn’t a concern until, suddenly, it is the only concern.  Risk asset markets, while continuing to ascend, are also doing so on less and less breadth.  Again, I would contend that hedging remains a critical activity for the corporate set.

Looking around markets today, yesterday’s euphoria, while evident in Asia overnight, has not made its way to Europe.  Japan’s Nikkei (+1.4%) led the way in Asia despite GDP data printing at a much lower than expected -3.6% in Q3.  It seems to me any idea that the BOJ will consider reducing its support for the economy is misplaced.  If anything, I would anticipate increased support as the nation tries to dig itself out of its latest economic hole.  As to the rest of Asia, the Hang Seng (+0.1%) lagged as its tech sector continues to be undermined by Xi’s ongoing crackdown on Chinese tech behemoths, but Shanghai (+1.1%) with far less tech exposure, did fine.

Europe, on the other hand, is under a bit of pressure this morning with the DAX (-0.6%) leading things lower followed by the CAC (-0.3%) while the FTSE 100 is little changed on the day.  The big news in Germany is that Angela Merkel is officially out as Chancellor and Olaf Scholz was sworn in as the new leader of the nation.  I don’t envy his situation as energy prices are rising sharply and Germany is entirely reliant on Russia and Vladimir Putin for the natural gas necessary to stay warm this winter, while their export-led economy is so tightly tied to China’s performance, that the ongoing slowdown there will soften growth prospects.  But then again, as a Social Democrat, maybe that is exactly the position Scholz relishes.

Finally, US markets remain in euphoria mode with futures all pointing higher by another 0.4% at this hour with the S&P 500 less than 1% from its all-time high.

The bond market, this morning, is showing no clarity whatsoever.  Treasury yields, after backing up 5bps yesterday, are actually lower by 0.8bps despite the positive look from equities.  Bunds and OATs are little changed while Gilts (-1.4bps) are showing the most strength.  Perhaps of more interest are the PIGS, where yields are rising sharply (Italy +3.2bps, Greece +4.9bps) after comments from Latvian ECB member, Martin Kazaks, that there was little reason to continue with additional QE once PEPP expires in March.  I suspect the Greeks and Italians would have a different opinion!

Last week, commodity prices were under huge pressure, led by oil, which cratered in the wake of the Thanksgiving holiday.  This morning, WTI (+0.75%) and Brent (+1.0%) are continuing their strong rebound with both grades more than 12% off their recent lows.  NatGas (+3.9%), too, is rebounding but has much further to go to reach the peaks seen in October.  Metals market, on the other hand, are having a less interesting day with gold (+0.1%) and copper (+0.1%) just edging up a bit.

Turning to the dollar, it is broadly, but not universally weaker this morning with NOK (+0.6%) leading the way on the back of oil’s rebound, although the rest of the G10 gainers are far less impressive (AUD +0.2%, CAD +0.1%).  There are some laggards as well with GBP (-0.35%) falling after news that PM Johnson is about to impose new travel restrictions in the country.  Now, if the UK combines tightening monetary policy, at which the BOE has hinted, with omicron inspired restrictions, that is clearly a recipe for slowing growth, and a weaker pound and FTSE.  In fact, the pound has fallen to its lowest level in almost exactly 12 months this morning.  In the EMG space, only TRY (-1.3%) is really falling and that story is consistent.  On the plus side, though is THB (+0.6%), RUB (+0.4%) and ZAR and MXN (both +0.35%) as the commodity sector continues to perform well while Thailand powered ahead on reduced omicron fears.  So, the UK is reacting one way while the Thai government is going in the opposite direction!

On the data front, yesterday’s productivity and labor cost data were even more awful than forecast and Consumer Credit rose far less than anticipated and barely 56% as quickly as September.  This morning brings only the JOLTs report (exp 10469K) which means that with the lack of Fed speakers, the FX market will look elsewhere for drivers. As long as risk remains in vogue, I expect the dollar to remain under some pressure, but if the European equity impulse comes here, look for the dollar to recoup its losses before the day is over.

Good luck and stay safe
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Opening Move

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Forty trillion yen
Kishida’s opening move?
Or his legacy?

While it has been quite a week in the FX markets, and in truth, markets in general, it appears that both traders and investors are now tired and price volatility has ebbed.  While inflation remains topic #1 in most discussions, that poor horse has been beaten into submission at this point.  We already know that it is running hotter than most forecasts and that its composition is broadening.  This means the idea that Covid related issues, like used car prices or lumber prices, which have spiked (and in the case of lumber receded somewhat) due to supply chain issues is clearly no longer the only factor.  In fact, wages are beginning to rise substantially and with higher commodity prices, input costs continue to climb (see PPI) which is rapidly feeding into retail costs.  And it doesn’t appear this is set to slow anytime soon, despite the wishful comments by every central banker and finance minister around.  So, what’s a country to do?

Well, if you’re Japan, this is the perfect time to…spend more money!  And so, last night it was reported that new PM, Fumio Kishida, will be proposing a ¥40 trillion stimulus package in order to help support growth.  The rationale is that GDP is forecast to have contracted in Q3, rather than following in the footsteps of other major nations which all saw varying levels of growth.  Meanwhile, this being Japan, the home of the permanent deflationary impulse, one ought not be surprised at the fact that the BOJ and the government completely dismiss the recent PPI data (8.0% in October, a full point above expectations) as transitory given the decision that this will shore up the government’s approval rating.  And anyway, all the forecasts point to a still subdued 0.1% Y/Y CPI reading next week so there should be nothing to worry about.  After all, economic forecasts for inflation have been spot on around the world lately!

Since the last week of September, when USDJPY broke out of a six-month long trading range, the yen has fallen nearly 5%.  I believe that the BOJ is extremely encouraging of this movement as it has been a tacit policy goal since the initiation of Abenomimcs in 2012, when the BOJ really went all-in on its QE initiative in an effort to defeat deflation.  One thing for the Japanese to consider, though, is that history shows getting a little inflation is a very hard thing to do.  Once that genie is out of the bottle, it tends to be far more unruly than anticipated.  For Japan’s sake, I certainly hope that the PPI data is the outlier, but the risk of a policy mistake seems to be growing.  And after all, central bank policy mistakes are all the rage now (see Federal Reserve), so perhaps Kuroda-san just wants to feel like a member of the club.  At any rate, this morning the yen appears to be readying for the next leg lower and I would not be surprised at a move toward 116.75 before it’s all over.

But truthfully, there is not much to tell beyond that.  As mentioned, there is still a lot of discussion regarding inflation and its various causes and effects.  One thing to keep in mind is that history has shown the currencies of nations with high inflation tend to fall over time.  And this does not have to be hyperinflation, merely inflation running hotter than its peers.  Consider Italy, pre euro, where inflation averaged 5.4% and the currency regularly depreciated to offset the growth in prices.  In fact, the entire economic model was based on a depreciating currency to maintain the country’s industrial competitiveness.  The same can be seen in Turkey today, where each higher than expected CPI print leads to further lira weakness.

The point is, while Japan may not be able to create inflation, it is abundantly clear that we have done so in the US.  And when push comes to shove, if/when the Fed has to implement policy to support financial stability, they will be faced with the “impossible trinity” where of the three markets in question, stocks, bonds and the dollar, they will support the first two and allow the dollar as the outlet valve.  This means that eventually, a much weaker dollar is likely on the cards, not in the next several months, but very possibly within the next 2 years.  For payables hedgers, especially with the dollar showing short term strength, it may be an excellent time to consider longer term protection.  USD puts are very cheap these days.  Let’s talk.

Ok, so what do I mean by dull markets?  Well, equities are mostly higher, but generally not by very much.  In Asia, the Nikkei (+1.1%) was the big winner on the stimulus news, but both the Hang Seng (+0.3%) and Shanghai (+0.2%) were only modestly better on the night.  In Europe too, the movement has been relatively modest with the UK (FTSE 100 -0.4%) even falling on the day although the other major markets (DAX +0.1%, CAC +0.4%) are a bit firmer.  US futures are also pointing higher, with gains on the order of 0.2% across the board.

Bond markets are mixed as Treasuries (+2.2bps) are softer after yesterday’s holiday, but European sovereigns are all seeing modest yield declines (Bunds -0.9bps, OATs -0.6bps, Gilts -0.9bps).  That said, the peripheral markets also selling off a bit with Italian BTPs (+2.8bps) and Greek GGBs (+3.1bps) leading the way lower.

Commodities are actually the one market where there is still some real volatility as oil (-2.1%) leads the way lower alongside NatGas (-2.8%), although there is weakness in gold (-0.6%) and copper (-0.4%), all of which have had strong weeks.  Frankly, this feels like some position closing after a positive outcome rather than the beginning of a new trend.  In fact, if anything, what we have seen this week is commodity prices breaking out of consolidations and starting higher again.  Agriculturals are little changed and the other industrial metals like Al (+1.1
%) and Sn (+0.6%) are actually a bit better bid.  In other words, there doesn’t appear to be a cogent theme today.

As to the dollar, mixed is the best adjective today.  In the G10, we have several gainers led by the pound (+0.2%) as well as several laggards led by SEK (-0.4%).  The thing is, there is very little to hang your hat on with respect to stories driving the activity.  Neither nation published any data and there haven’t been any comments of note either.  In the EMG space, PHP (+0.6%) is the leading gainer on the strength of equity market inflows as well as central bank comments indicating they will seek to allow the market to determine the exchange rate.  On the downside, RUB (-1.0%) is falling sharply on the back of oil’s sell-off and rising geopolitical tensions with Russia complaining about NATO activity near its borders.  Between those two extremes, however, the movement is limited and pretty equal on both sides in terms of the number of currencies rising or falling.  Last night, Banxico raised rates by 25bps, as widely expected and the peso is weaker this morning by -0.25% alongside oil’s decline.

Data-wise, JOLTS Jobs (exp 10.3M) and Michigan Sentiment (72.5) are both 10:00 numbers, but neither seems likely to move markets.  NY Fed president Williams speaks at noon, so perhaps there will be something there, but I doubt that too.

For now, the dollar’s trend is clearly higher in the short term, especially if we continue to see Treasury yields climb.  However, as mentioned above, I think the medium-term story can be far more negative for the greenback, so consider that as you plan your hedging for 2022 and beyond.

Good luck, good weekend and stay safe
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Raring to Spend

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Japan’s new PM
Fumio Kishida is
Raring to spend yen

The LDP elected Fumio Kishida as its new president, thereby assuring him of the job of Japan’s 65th Prime Minister.  Relacing Yoshihide Suga, Kishida-san has a tall task ahead of him in leading the nation back to a growth trajectory.  In addition, he must face the voters by November as well as rally his supporters in an upper house election next year.  Apparently, his plan is…spend more money!  He has promised to spend tens of trillions of yen (hundreds of billions of dollars equivalent) in order to help resuscitate the Japanese economy and bolster the middle class.

As refreshing as it is to have a new administration, it seems as though the policy playbook continues to consist of a single page…spend more yen.  Perhaps something will change in Japan, but it seems unlikely.  Rather, the nation will continue to struggle with the same macroeconomic issues that have plagued it for the past decades; excess debt driving slower growth amid an aging population.  The yen (+0.1%) has stabilized this morning but appears to be trending pretty sharply lower.  While support (USD resistance) is strong at 111.65-85, should we breech that level, a move toward 115.00 appears quite reasonable as well as likely.

As energy prices rise higher
Most governments seek a supplier
Of power that will
Completely fulfil
The orders that they all desire

In other news, it is becoming abundantly clear that the combination of energy policies that have been enacted recently are not having the desired outcome, assuming that outcome is to develop clean energy in abundance.  This is made evident by the dramatically rising prices of things like natural gas in Europe (+400% since 1Mar21) and the US (+130% YTD) and coal (+160% YTD).  Of course, the latter is rarely considered ‘clean’ but it is reliable.  And that is the crux of the matter.  Reliability of both wind and solar power has been called into question lately and reliance on baseload power sources like coal, which Europe, China, and India have in abundance, and NatGas, which they don’t, is driving policy decisions.

For instance, China is mulling energy price hikes for industry in an effort to reduce demand.  And if that doesn’t work, they will raise prices for residential users.  Go figure, a communist nation using price signals to adjust behavior!  At any rate, the immediate impact is likely to be downgraded growth prospects for China’s economy as rising energy prices will lead to rising export prices, lower exports, and lower growth.  We have already seen Chinese equity markets under pressure recently as the energy situation worsens.  Shanghai (-1.8%, -5.5% in past two weeks) is leading the way lower amid growing concern that Evergrande is not the biggest problem impacting China.  At some point, I expect the renminbi is going to suffer a bit more than its recent price action has shown.  Slowing growth and continued monetary expansion are going to add a great deal of pressure to the currency as it may be the only outlet available for the economy.  I fear it could be a “long cold lonely winter” in China this year.

Of course, it’s not just China where energy prices are rising, they are higher everywhere.  I’m sure you see it when you refill your gas tank, or when you pay your electric bill.  And this is a problem for economic growth as higher energy costs feed into product and service pricing directly, as well as reduce the amount of disposable income available for spending by the population.  Higher prices and slower growth (i.e. stagflation) are a very real risk, and by some measures have already arrived.

Beyond the direct discomfort we all will feel from its impacts, the policy questions are critical.  Consider, last time stagflation was upon us, then Fed Chairman Paul Volcker raised interest rates sharply in order to attack the inflation issue driving the US economy into a severe double-dip recession.  Oh yeah, the S&P 500 fell nearly 30% over the two-year period.  But ask yourself if, given the current zeitgeist as well as the current makeup of the Fed, there is any possibility that Chairman Powell (or his successor) will attack inflation in the same way.  It seems highly unlikely that would be the case.  Rather, it is a virtual certainty that the focus will be on the ‘stag’ part of the term and more money printing and spending will be recommended.  After all, given the increasing acceptance of the MMT mindset, that’s all that needs to be done.  Remember, policies matter, and if policies are designed to achieve short-term goals at the expense of longer-term needs, the ultimate outcome tends to be poor.  As in China, the currency is likely to be the relief valve for the economy which is what informs my view of longer-term USD weakness.  However, for now, the dollar is following 10-year Treasury yields, which seem to be trending higher, albeit not today when they have fallen 4.2 basis points.

Summing it all up, rising energy prices are starting to have deleterious effects on all parts of the global economy and the financial market implications are only going to grow.  In addition, the policy actions going forward are critical, and the chance of a policy error seem to grow daily.  The idea of short-term pain for long-term gain is obsolete in the year 2021.  Be prepared for more problems in the future.

Ok, a quick run around markets shows that after yesterday’s sharp US equity sell-off, Japan (Nikkei -2.1%) followed suit as did Shanghai although the Hang Seng managed to rally 0.7%.  Europe, on the other hand has decided that central banks will come to the rescue, as we are seeing a nice rebound from yesterday’s price action (DAX +1.1%, CAC +1.2%, FTSE 100 +1.0%).  US futures, too, are higher led by the NASDAQ (+1.0%) as declining yields are helping out.

But are yields really declining?  The fact that the bond market has bounced slightly after a dramatic 1-week decline is hardly a sign of a rebound.  Rather, it is normal trading activity.  While the trend remains for higher yields, today, all of Europe has seen yields slide on the order of 2 basis points alongside the Treasury yield declines.  This feels very much like a lull in the action, not a top/bottom in the market.

Commodity prices are behaving in a similar manner as oil (-0.8%) and NatGas (-1.2%) are leading the way lower, consolidating what has been an impressive rally.  Metals prices are mixed with gold (+0.6%) rebounding but base metals (Cu -0.4%, Al -0.2%, Sn -0.6%) all sliding.  Agricultural prices are mixed as the overall session seems to be one of position adjustments after a big move.

As to the dollar, it is mixed, albeit slightly firmer if anything.  In the G10, NOK (-0.35%) is falling alongside oil prices with NZD (-0.3%) the next worst performer on weakening commodity prices.  JPY (+0.1%) and CHF (+0.1%) are both modestly firmer, but here, too, things seem more position oriented than trend worthy.  EMG currencies are mixed with an equal number of gainers and losers, but the notable thing is that the biggest movers have only seen price adjustments of 0.3% or less.  In other words, there are precious few stories here to think about.

There is no data of note this morning, but we do hear from a lot of central bankers, notably Chairman Powell alongside Lagarde, Kuroda and Bailey (BOE) at an ECB forum.  We also hear from Harker, Daly and Bostic, but the narrative remains tapering is coming in November, and none of these three will be able to change that narrative.

In truth, I would have expected the dollar to soften today given the bond market, so the fact it remains reasonably well bid is a sign that there is further strength in this move.  The euro is pushing to critical technical support at 1.1650, a break of which is likely to see a much sharper decline.  Hedgers, keep that in mind.

Good luck and stay safe
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Thrilled…Chilled

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The ECB just must be thrilled
Inflation they’ve tried hard to build
Is finally growing
Though Germany’s showing
The growth impulse there has been chilled

The news from the Continent this morning would seem to be pretty good.  GDP, which rose 2.0% Q/Q in Q2 was substantially higher than the forecast 1.5%.  The growth leadership came from Spain (2.8%) and Italy (2.7%) although France (0.9%) was somewhat lackluster and Germany (1.5%) was extremely disappointing, coming in well below expectations.  At the same time, Eurozone CPI rose to 2.2% in July, above both the expected 2.0% print, and the ECB’s target rate.  Given everything we have heard from Madame Lagarde and virtually every ECB speaker over the past months, this must be quite exciting as it is a demonstration of success of their policies.  It seems that buying an additional €3.3 trillion in assets was finally sufficient to drive inflation higher.  (Well, arguably, what that did was drive up the price of virtually every commodity while government lockdowns were able to reduce productive capacity sufficiently to create massive bottlenecks in supply chains forcing prices higher.)  Nonetheless, the ECB gets to take a victory lap as they have achieved their target.

As an aside, you may recall yesterday’s data that showed German CPI rose a shockingly high 3.8%, a level at which the good people of that nation are very likely horrified.  While the Eurozone, as a whole, continues to recover pretty well, there must be a little concern that Germany is facing a period of stagflation, with subpar growth and higher prices.  Of course, this is the worst possible outcome for policymakers as the remedy for the two aspects require opposite policies and thus a choice must be made that will almost certainly result in greater pain for the economy initially.  Forty years ago, Fed Chair Paul Volcker was able to withstand the political heat when making this decision, but I fear there is not a central banker in the seat who could do so today.

Perhaps the most disappointing aspect of all this is that European equity markets are all in the red, with not a single one responding positively to the data.  Ironically, Spain’s IBEX (-1.0%) is the laggard, despite Spain’s top of the list growth.  Then comes the DAX (-0.8%) and the CAC (-0.25%).  For good measure, the FTSE 100 (-0.9%) is following suit although its GDP data won’t be published for two more weeks.  Arguably, despite this positive news, the ongoing spread of the delta variant seems to be undermining both confidence and actual activity at some level.

Of course, European markets tend to take their cues from what happens in Asia before they open, and last night was another risk-off session there with the Nikkei (-1.8%), Hang Seng (-1.35%) and Shanghai (-0.4%) all sliding.  There are two stories here, one Japanese and one Chinese.  From Japan, the issue is clearly the resurgence of Covid as the recently imposed emergency lockdown has been extended further amid a spike in daily cases to near 10K, higher than the peaks seen in both January and May of this year.  The rapid spread of the disease has policymakers there quite flustered and investors are beginning to show their concern.

China, on the other hand, assures us that they have no Covid problems, rather markets there are suffering over policy decisions.  One observation that might be made is that the government is enhancing regulations on very specific segments of the economy in order to achieve their stated goals from the most recent 5-year plan.  So, education is very clearly seen as critical, far too important for capitalism to have any influence, and I would expect that this industry sector will ultimately privatize and turn into the suggested non-profit organizations.  On the tech side, China is all about hardware type tech, and will do all they can to support companies in that space.  However, companies like Didi, AliBaba and Tencent don’t produce anything worthwhile, they simply consume resources to provide retail services, none of which lead toward Xi Jinping’s ultimate goals.  As such, they are likely to find increasing restrictions on what they do in order to reduce their influence on the economy.

And as I hinted at the other day, there appears to be growing concern that the real estate bubble that exists in China has been a key feature of their demographic problems.  Couples are less likely to have children if they cannot afford to buy a house, and the damage from China’s one-child policy will take generations to repair, although that is a key focus of the government.  As such, do not be surprised if real estate firms come under pressure with respect to things like restrictions on margins and pricing as the government tries to deflate that bubble.  This opens the possibility that yet another sector of the Chinese equity market is going to come under further pressure.  To the extent that Asian markets set the tone for the global day, that does not bode well for the near future.

Interestingly, despite a lackluster performance by the European and Asian equity markets (and US futures, which are all lower this morning), the bond markets are not exactly on fire.  While it is true that Treasury yields have slipped 2.5bps, European sovereigns are either side of unchanged today, with nothing moving more than 0.3bps in either direction.  I would have expected a bit better performance given the equity risk-off signal.

Commodity markets are generally a bit softer with oil (-0.2%) slipping a bit although it has recovered almost all of its losses from two weeks ago and sits at $73.50/bbl.  Gold, after a huge rally yesterday is unchanged this morning, while base metals are mixed (Cu -0.2%, Al +1.4%, Sn +0.15%).  Finally, ags are all softer this morning as weather conditions in key growing areas have improved lately.

Lastly, the dollar can best be described as mixed, with NOK (-0.4%) and AUD (-0.35%) the laggards amid softer oil and  commodity prices while EUR (+0.1%) and CHF (+0.1%) have both edged higher on what I would contend is the ongoing decline in real US interest rates.

Emerging market currencies have performed far better generally with TRY (+0.6%) and PHP (+0.6%) the leaders although both EEMEA and other APAC currencies have performed well.  The lira responded to the Turkish central bank raising its inflation forecast thus implying rates would remain higher there for the foreseeable future.  Meanwhile, the peso seemed to benefit from the idea that the renewed covid lockdown would reduce its balance of payments issues by reducing its trade deficit.  On the other side of the ledger was KRW (-0.3%) which continues to suffer from the uncertainty over Chinese business activity.

On the data front today, we get the Fed’s key inflation reading; Core PCE (exp 3.7%) as well as Personal Income (-0.3%), Personal Spending (0.7%), Chicago PMI (64.1) and Michigan Sentiment (80.8).  Clearly all eyes will be on the PCE number, where a higher print will likely encourage more taper talk.  However, if it is below expectations, look for a very positive market response.  We also hear from two Fed speakers, Bullard and Brainerd, the former who has turned far more hawkish and has been calling for a taper, while Ms Brainerd is not nearly ready for such action.  And in the end, Brainerd matters more than Bullard for now.

I expect the market will take its cues from the PCE data, with a higher print likely to undermine the dollar while a softer print could well see a bit of a rebound from the past several sessions’ weakness.

Good luck, good weekend and stay safe
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Chaos Prevailed

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In Washington, chaos prevailed
As Congress’s job was derailed
Investors, though, thought
‘Twas nothing, and bought
More stocks with the 10-year was assailed

One of the more remarkable aspects of the chaotic events in Washington, DC yesterday was the fact that the market reaction was completely benign.  On the one hand, given the working assumption that the theatrics would not affect the ultimate outcome, it is understandable.  On the other hand, the fact that there continues to be this amount of discord in the nation in the wake of a highly contentious election bodes ill for the ability of things to quickly return to normal.  In the end, though, market activity indicates the investment community firmly believes there will be lots more fiscal stimulus as the new Biden administration tries to address the ongoing pandemic driven economic issues.  Hence, the idea behind the reflation trade remains the current narrative, with more stimulus leading to faster economic growth, while increased Treasury supply to fund that stimulus leads to higher long end yields and a steeper yield curve.

However, now that the formalities of the electoral vote counting have concluded, focus has turned back to the narrative on a full-time basis, with the ongoing argument over whether inflation or deflation is in our future, as well as the question of whether assets, generally, are fairly valued or bubblicious.  The thing is, away from the politics, nothing has really changed very much lately.

Covid-19 continues to spread and the resultant lockdowns around the world continue to be expanded and extended.  Just last night, for instance, Japan declared a limited state of emergency in Tokyo and three surrounding prefectures in an effort to stem the spread of Covid.  That nation has been dealing with its highest caseload since April, and the Suga government was responding to requests for help from the local governments.  Meanwhile, in Germany, on Tuesday lockdowns were extended through the end of January and restrictions tightened to prevent travel of more than 15km from one’s home.  And yet, this type of news clearly does not dissuade investors as last night saw the Nikkei rally 1.6% while the DAX, this morning, is higher by 0.4% after a 1.75% rally yesterday.  In the end, the narrative continues to highlight the idea that the worse the Covid situation, the greater the probability of further fiscal and monetary stimulus, and therefore the bigger the boost to growth.

At the same time, the reflation piece of the narrative continues apace with Treasury yields continuing to climb, edging higher by one more basis point so far this morning after an eight basis point rise yesterday.  Something that has received remarkably little attention overall is the fact that oil prices have been rallying so steadily of late, having climbed more than 40% since the day before the Presidential election, and given the pending supply reductions, showing no signs of backing off.  This, along with the ongoing rallies in most commodities, is part and parcel of the reflation trade, as well as deemed a key piece of the ultimate dollar weakness story.

Regarding this last observation, there is, indeed, a pretty strong negative correlation between the dollar’s value and the price of oil.  Of course, the question to be answered is the direction of causality.  Do rising oil prices lead to a weaker dollar?  Or is it the other way round?  If it is the former, then the dollar’s future is likely to be one of weakness as the supply reductions in US shale production alongside the Saudi cuts can easily lead to further gains of $10-$15/bbl.  However, the dollar is impacted by many things, notably Fed policy, and if the dollar is the driver of oil movement, the future of the black, sticky stuff is going to be far less certain.  If, for example, inflation rises more rapidly than currently anticipated, and forces the market to consider that the Fed may react by reducing policy ease, the dollar could easily find support, especially given the massive short positions currently outstanding.  Would oil continue to rise into that circumstance?  The point is, correlations are fine to recognize, but as a planning tool, they leave something to be desired.  Understanding the fundamentals underlying price action remains critical to plan effectively.

As to today’s session, the risk picture has turned somewhat mixed.  As mentioned above, Asian equity prices had a pretty good day, with Shanghai (+0.7%) rising alongside the Nikkei, although the Hang Seng (-0.5%) struggled.  European bourses are mixed, with the DAX (0.4%) leading and the CAC (+0.1%) slightly higher although the FTSE 100 (-0.5%) is under pressure.  There is one outlier here, Sweden, where the OMX has rallied 2.1% this morning, although there is no general news driving the movement.  In fact, PMI Services data was released at its weakest level since the summer, which hardly heralds future strength.

We’ve already discussed Treasury weakness but the picture in Europe is more mixed, with bunds (-1bps) and OATs (-0.5bps) rallying slightly while Gilts (+1.7bps) are under pressure alongside Treasuries.

And finally, the dollar is showing some solid gains this morning, higher against all its G10 counterparts and most of the EMG bloc.  Despite ongoing strength in the commodity space, AUD (-0.75%) leads the way lower with NZD (-0.6%) next in line.  Clearly, the market did not embrace the Japanese news on the lockdown, as the yen has declined 0.6% as well.  As to the single currency, it has fallen 0.5%, with a very strong resistance level building at 1.2350.  It will take quite an effort to get through that level in the short run.

Emerging markets declines are led by CLP (-1.85%) and ZAR (-1.0%), although the weakness is nearly universal.  Interestingly, the Chile story is not about copper, which continues to perform well, but rather seems to be a situation where the currency is being used as a funding currency for carry trades in the EMG bloc.  ZAR, on the other hand, is suffering alongside gold, which got hammered yesterday and is continuing to soften.

On the data front, today brings Initial Claims (exp 800K), Continuing Claims (5.2M), the Trade Balance (-$67.3B) and ISM Services (54.5).  Remember, tomorrow is payrolls day, so there may be less attention paid to these numbers this morning.  One cautionary tale comes from the Challenger Job Cuts number, which is released monthly but given limited press.  Today, it jumped 134.5% from one year ago, a significant jump on the month, and a bad omen for the employment picture going forward.  With this in mind, it seems highly unlikely the Fed will do anything but ease policy further in the near term.  One other thing, yesterday the December FOMC Minutes were released but had no market impact.  Recall, the December meeting occurred prior to the stimulus bill or the Georgia run-off election, so was missing much new information.  But in them, the FOMC made clear that the bias was for a dovish stance for a long time to come.  Based on what we heard from Chicago’s Evans on Tuesday, it doesn’t seem that anything has changed since then.

Given the significant short dollar positions that are outstanding in the investment and speculative communities, the idea that the dollar could rally in the near term is quite valid.  While nothing has changed my longer-term view of rising inflation and deeper negative real yields undermining the dollar, that doesn’t mean we can’t jump in the near term.

Good luck and stay safe
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Spring Remains Distant

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From Brussels, a letter was sent
To London, with which the intent
Was telling the British
The EU’s not skittish
So, don’t try, rules, to circumvent

The pound is under pressure this morning, -0.6%, after it was revealed that the EU is inaugurating legal proceedings against the UK for beaching international law.  The details revolve around how the draft Internal Market Bill, that has recently passed through the House of Commons, is inconsistent with the Brexit agreement signed last year.  The specific issue has to do with the status of Northern Ireland and whether it will be beholden to EU law or UK law, the latter requiring a border be erected between Ireland, still an EU member, and its only land neighbor, Northern Ireland, part of the UK.  Apparently, despite the breathless headlines, the EU sends these letters to member countries on a regular basis when they believe an EU law has been breached.  As well, it apparently takes a very long time before anything comes of these letters, and so the UK seems relatively nonplussed over the issue.  In fact, given that the House of Lords, which is not in Tory control, is expected to savage the bill, it remains quite unclear as to whether or not this will be anything more than a blip on the Brexit trajectory.

However, what it did highlight was that market participants have grown increasingly certain that an agreement will be reached, hence the pound’s recent solid performance, and that this new wrinkle was enough for weak hands to be scared from their positions.  At this point, almost everything that both sides are doing publicly is simply intended to achieve negotiating leverage as time runs out on reaching a deal.  Alas for Boris, I feel that his biggest enemy is Covid, not Brussels, as the EU is far more concerned over the pandemic impact and how to respond there.  At the margin, while a hard Brexit is not preferred, the fear of the fallout in Brussels has clearly diminished, and so the opportunity for a hard Brexit to be realized has risen commensurately.  And the pound will fall further if that is the outcome.  The current thinking is there are two weeks left for a deal to be reached so expect more headlines in the interim.

The Tankan painted
A picture in black and white
Spring remains distant

Meanwhile, it is still quite cloudy in the land of the rising sun, at least as described by the Tankan surveys.  While every measure of the surveys, both small and large manufacturing and non-manufacturing indices, improved from last quarter by a bit, every one of them fell short of expectations.  The implication is that PM Suga has his work cut out for him in his efforts to get economic activity back up and running.  You may recall that CPI data on Monday showed deflation remains the norm, and weak sentiment is not going to help the situation there.  At the same time, capital flows continue to show significant foreign outflows in both stock and bond markets there.  It was only two weeks ago that the JPY (-0.1% today) appeared set to break through the 104 level with the dollar set to test longer term low levels.  Of course, at that time, the market narrative was all about the dollar falling sharply.  Well, both of those narratives have evolved, and if capital continues to flow out of Japan, it is hard to make the case for yen strength.  Remember, the BOJ is never going to be seen as relatively tighter in its policy stance, so a firmer yen would require other drivers.  Right now, they are not in evidence.

And frankly, those are the two most interesting stories in the market today.  Arguably, the one other theme that has gained traction is the rise in layoffs by large corporations in the US.  Yesterday nearly 40,000 were announced, which is at odds with the idea that the economy here is going to rebound sharply.  On an individual basis, it is easy to understand why any given company is reducing its workforce in the current economic situation.  Unfortunately, the picture it paints for the immediate future of the economy writ large is one of significant short-term pain.  Given this situation, it is also easy to understand why so many are desperate for Congress to agree a new stimulus bill in order to support the economy.  And it’s not just elected officials who are desperate, it is also the entire bullish equity thesis.  Because, if the economy turns sharply lower, at some point, regardless of Fed actions, equity markets will reprice lower as well.

But that is not happening today.  As a matter of fact, equities are looking pretty decent, yet again.  China is closed for a series of holidays, but the overnight session saw strength in Australia (+1.0%) although the Nikkei (0.0%) couldn’t shake off the Tankan blues.  Europe, however, is all green led by the FTSE 100 (+0.9% despite that letter) with the CAC (+0.65%) and DAX (+0.1%) also positive.  US futures are all pointing higher with gains ranging from 0.8%-1.25%.

Bond markets actually moved yesterday, at least a little bit, with 10-year Treasury yields now at 0.70%.  Yesterday saw a 3.5 basis point move with the balance occurring overnight.  Given yesterday’s equity rally, this should not be that surprising, but given the recent remarkable lack of movement in the bond market, it still seems a bit odd.  European bond markets are behaving in a full risk on manner as well, with havens like Bunds, OATS and Gilts all seeing yields edge higher by about 1bp, while Italy and Greece are seeing increased demand with modestly lower yields.

As to the dollar overall, despite the pound’s (and yen’s) weakness, it is the dollar that is under pressure today against both G10 and EMG currencies.  Today’s leader in the G10 clubhouse is NOK (+0.55%) which is a bit odd given oil’s 1.0% decline during the session.  But after that, the movement has been far less enthusiastic, between 0.1% and 0.3%, which feels more like dollar softness than currency strength.

EMG currencies, however, are showing some real oomph this morning with the CE4 well represented (HUF +1.15%, PLN +0.85%) as well as MXN (+1.05%) and INR (+0.85%).  The HUF story revolves around the central bank leaving its policy rate on hold after a surprise 0.15% rise last week.  This was taken as a bullish sign by investors as the central bank continues to focus on above-target inflation there.  Meanwhile, inflation in Poland rose 3.2% in a surprise, above their target and has encouraged views that the central bank may need to tighten policy further, hence the zloty’s strength today.  The India story revolves around the government not increasing their borrowing needs, despite their response to Covid, which helped drive government bond investor inflows and rupee strength.  Finally, the peso seems the beneficiary of the overall risk-on attitude as well as expectations for an uptick in foreign remittances, which by definition are peso positive.

On the data front, yesterday saw ADP surprise higher by 100K, at 749K.  As well, Chicago PMI, at 62.4, was MUCH stronger than expected.  This morning brings Initial Claims (exp 850K), Continuing Claims (12.2M), Personal Income (-2.5%), Personal Spending (0.8%), Core PCE (1.4%) and ISM Manufacturing (56.4).  US data, despite the layoff story, has clearly been better than expected lately, and this can be seen in the increasingly positive expectations for much of the data.  While European PMI data this morning was right on the button, the numbers remain lower than those seen in the US.  In addition, the second wave is clearly hitting Europe at this time, with Covid cases growing more rapidly there than back in March and April when it first hit.  As much as many people want to hate the dollar and decry its debasement (an argument I understand) it is hard to make the case that currently, the euro is a better place to be.  While the dollar is soft today, I believe we are much closer to the medium-term bottom which means hedgers should be considering how to take advantage of this move.

Good luck and stay safe
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Prices Keep Falling

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Suga-san’s ascent
Has not altered the landscape
Prices keep falling

The distance between stated economic goals and actual economic outcomes remains wide as the economic impact of the many pandemic inspired government ordered lockdowns continues to be felt around the world.  The latest example comes from Japan, where August’s CPI readings fell, as expected, to 0.2% Y/Y at the headline level while the ex-fresh food measure (the one the BOJ prefers) fell to -0.4%.  Although pundits in the US have become fond of ridiculing the Fed’s efforts at raising inflation to 2.0%, especially given their inability to do so since defining that level as stable prices in 2012, to see real ineptitude, one must turn east and look at the BOJ’s track record on inflation.  In the land of the rising sun, the favored measure of CPI ex-fresh food has averaged 0.5% for the last 35 years!  The point is the Fed is not the first, nor only, central bank to fail in its mission to generate inflation via monetary policy.

(As an aside, it is an entirely different argument to discuss the merits of seeking to drive inflation higher to begin with, as there is a strong case to be made that limited inflation is a necessary condition for economic success at the national level.)  But 2.0% inflation has become the global central banking mantra. And though the favored inflation measure across nations often differs, the one key similarity is that every G10 nation, as well as many in the emerging markets, has been unable to achieve their goal.  The few exceptions are those nations like Venezuela, Argentina and Turkey that have the opposite problem, soaring inflation and no ability to control that.

But back to Japan, where decades of futility on the inflation front have put paid to the idea that printing money is all that is needed to generate rising prices.  The missing ingredient for all central banks is that they need to pump money into places that result in lending and spending, not simply asset purchases, or those excess funds will simply sit on bank balance sheets with no impact.

Remember, GDP growth, in the long run, comes from a combination of population growth and productivity growth.  Japan has the misfortune, in this case, of being one of the few nations on earth where the population is actually shrinking.  It is also the oldest nation, meaning the average and median age is higher there than any other country on earth (except Monaco which really doesn’t matter in this context).  The point here is that as people age, they tend to consume less stuff, spending less money and therefore driving less growth in the economy.  It is these two factors that will prevent Japan from achieving a much higher rate of inflation until such time as the country’s demographics change.  A new Prime Minister will not solve this problem, regardless of what policies he supports and implements.

Keeping this in mind, the idea that Japan is far more likely to cope with ongoing deflation rather than rising inflation, if we turn our attention to how that impacts the Japanese yen, we quickly realize that the currency is likely to appreciate over time.  Dusting off your Finance 101 textbooks, you will see that inflation has the side effect of weakening a nation’s currency, which quickly feeds into driving further inflation.  Adding to this impact is if the nation runs a current account deficit, which is generally the case when inflation is high and rising.  Harking back to Argentina and Venezuela, this is exactly the behavior we see in those economies.  The flip side of that, though, is that deflation should lead to a nation’s currency appreciating.  This is especially so when that nation runs a current account surplus.  And of course, you cannot find a nation that fits that bill better than Japan (well maybe Switzerland).  The upshot of this is, further JPY appreciation seems to be an extremely likely outcome.  Therefore, as long as prices cease to rise in Japan, there will be upward pressure on the currency.  We have seen this for years, and there is no reason for it to stop now.

Of course, as I always remind everyone, FX is a relative game, so it matters a great deal what is happening in both nations on a relative basis.  And in this case, when comparing the US, where prices are rising and the current account has been in deficit for the past two decades, and Japan, where prices are falling and the current account has been in surplus for the past four decades, the outcome seems clear.  However, the market is already aware of that situation and so the current level of USDJPY reflects that information.  However, as we look ahead, either negative surprises in Japanese prices or positive surprises in the US are going to be important drivers in the FX market.  This is likely to be seen in interest rate spreads, which have narrowed significantly since March when the Fed cut rates aggressively but have stabilized lately.  If the Fed is, in fact, going to put forth the easiest monetary policy around, then a further narrowing of this spread is quite possible, if not likely, and further JPY appreciation will ultimately be the result.  This is what we have seen broadly since the middle of 2015, a steady trend lower in USDJPY, and there is no reason to believe that is going to change.

Whew!  That turned out to be more involved than I expected at the start.  So let me quickly survey the situation today.  Risk is under modest pressure generally, although there were several equity markets that put in a good performance overnight.  After a weak US session, Asia saw modest gains in most places (Nikkei +0.2%, Hang Seng +0.5%) although Shanghai (+2.1%) was quite strong.  European markets are far less convinced of the positives with the DAX (+0.4%) and CAC (-0.1%) not showing much movement, and some of the fringe markets (Spain -1.3%) having a bit more difficulty.  US futures are mixed, although the top performer is the NASDAQ (+0.4%).

Bond markets continue to trade in a tight range, as central bank purchases offset ongoing issuance by governments, and we are going to need some new news or policies to change this story.  Something like an increase in the ECB’s PEPP program, or the BOE increasing its purchases will be necessary to change this, as the Fed is already purchasing a huge amount of paper each month.

And finally, the rest of the FX market shows that the dollar is broadly, but not universally under pressure.  G10 activity shows that NZD (+0.4%) is the leader, although JPY (+0.3%) is having another good day, while NOK (-0.25%) is the laggard.  But as can be seen by the modest movements, and given the fact it is Friday, this is likely position adjustments rather than data driven.

In the EMG space, KRW (+1.2%) was the biggest gainer overnight, which was hard to explain based on outside influences.  The KOSPI rose 0.25%, hardly a huge rally, and interest rates were unchanged.  The best estimate here is that ongoing strength in China is seen as a distinct positive for the won, as South Korea remains highly dependent on the mainland for economic activity.  Beyond the won, though, while there were more gainers than losers, the size of movement was not that significant.

On the data front, speaking of the current account, we see the Q2 reading this morning (exp -$160.0B), as well as Leading Indicators (1.3%) and Michigan Sentiment (75.0).  We also hear from three Fed speakers (Bullard, Bostic and Kashkari) but having just heard from Powell on Wednesday, it seems unlikely they will give us any new information. Rather, today appears to be a consolidation day, with marginal movements as weak positions get unwound into the weekend.

Good luck, good weekend and stay safe
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