Tag Archives: #JPY

Flat On His Face

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Poor Ishiba-san
Started with so much promise
Fell flat on his face

 

In what cannot be a major surprise in the current political zeitgeist, a fringe party that focused all its attention on inflation and immigration (where have we heard that before?) called Sanseito, captured 12 seats, enough to prevent Ishiba-san’s coalition of the LDP and Komeito from maintaining control of the Upper House of Parliament there.  The electoral loss has increased pressure on PM Ishiba with many questioning his ability to maintain his status for any extended length of time.  While he is adamant that he is going to continue in the role, and that he is fighting the good fight for Japan with respect to trade talks with the US, it appears that the population has been far more focused on the cost of living, which continues to rise, and the increase in foreign visitors in the nation.  Sanseito describe themselves as a “Japan First” party.

Consider, for a moment, the cost of living in Japan.  For the 30 years up until 2022, as you can see from the chart below taken from FRED data, the average annual CPI was 0.44%.  

In fact, the imperative for Japanese monetary policy was to end the decades of deflation as it was deemed a tremendous drag on the economy.  This was the genesis of their Negative Interest rate policy as well as their massive QE program, which went far beyond JGBs into equities and ETFs.  Now, while the economists and politicians hated deflation, it wasn’t such a bad thing for the folks who lived there.  Think of your life if prices for stuff that you consume rose less than 1% a year for 20-30 years.  

But now, under the guise of, be careful what you wish for, you just may get it, the Japanese government has been successful in raising the nation’s inflation rate to their 2.0% target and beyond and have shown no ability to halt the process.  After all, the Japanese overnight rate remains at 0.50% leaving real rates significantly negative, which is no way to fight inflation.   So, while Ishiba-san explained to the electorate that he was defending Japan’s pride and industry, the voters said, we want prices to stop rising.  

The biggest problem for Japan is that they now have less than 2 weeks to conclude a trade deal with the US based on the latest timeline, and their government is weak with no mandate on trade.  It is not impossible that Japan caves on most issues because if they fight, given the government’s current status, it could be a lot worse.

Now, Friday, when I discussed this possibility, I made that case that if the LDP lost the Upper House majority, it would be a distinct negative for both the yen and the JGB market.  Well, as you can see in the chart below, the first call has thus far been wrong with the USDJPY falling a full yen right away, and after an initial bounce, it has resumed that downtrend.  Like the dollar’s strength when the GFC exploded in 2008, despite the fact that the US was the epicenter of the problem, it appears that Japanese investors are bringing more money home as concern over the future increases.  Over time, I expect that the yen is likely to weaken, but I guess not yet.

Source: tradingeconomics.com

As to JGBs, Japan was on holiday last night, celebrating Sea Day, so there was no market in Tokyo.  While there is a JGB futures market, there was very little activity, and we will need to wait until this evening to learn their fate. 

The deadline for trade talks is looming
And Europe, responses, are grooming
If talks fall apart
And cut to the heart
Of what people there are consuming

The other story that is getting discussed this morning is the fast-approaching trade talk deadline of August 1st.  The EU has been actively negotiating to achieve a deal and there appears to be a decent chance that something will be concluded.  However, this morning’s stories are all about how Europe is preparing a dramatic response (“if they want war, they’ll get war” according to German Chancellor Merz) if they cannot reach a deal and the US imposes much higher tariffs on EU exports.  It is actually quite amusing to see the framing of Europe as the righteous entity being unfairly treated and forced to create a response to the American bullies.  But, that is the message from the WSJ and Bloomberg, and I’m sure from the other news sources that I don’t follow.

Every time I consider the trade situation, and the speed with which President Trump is working to conclude deals, I am amazed at how quickly this is all coming about.  Consider that the Doha Development Round of trade talks was launched in 2001 and IS STILL ONGOING with no resolution yet.  The previous framework, the Uruguay Round took 8 years to complete.  Thus, perhaps the question should be, why have trade talks taken so long in the past.  Much has been made of how President Trump blinked when the original 90-day window closed and so extended the timeline for a few weeks.  Apparently, the use of more sticks and fewer carrots is what has been needed to get these things moving along.  Otherwise, trade negotiators had cushy jobs with no accountability and no responsibility, so no incentive to come to an agreement.

Many analysts have explained that the US will suffer from these deals as inflation will rise because of tariffs and growth will slow.  Of course, these were the same analysts who explained that tariffs by the US would result in other nations’ currencies weakening to offset the tariff.  Once again, I would highlight that old analyst models are not fit for purpose in the current world situation.  I have no idea if there will be a successful conclusion of these deals, but I won’t bet against that outcome.  In the end, as I have repeatedly explained, the US has been the consumer of last resort for nations around the world, and loss of access to the US market is a major problem for everybody else.  That is a very large incentive to agree to deals.

Ok, enough, let’s see how things look this morning.  Tokyo was closed last night but we saw gains in Hong Kong (+0.7%) and China (+0.7%) as the PBOC maintained its policy ease supporting the economy.  In fact, Chinese money supply has been growing recently which should help the economy there, although it is still struggling a bit.  The rest of the region was a mixed bag with some gainers (Korea, India, Indonesia) and some laggards (Taiwan, Australia, Malaysia).  In Europe this morning, equities are under some pressure with the CAC (-0.5%) the laggard, although all bourses are lower.  This appears to be trade related with some concerns things won’t work out.  As to US futures, at this hour (7:05), they are pointing higher by about 0.25%.

In the bond market, yields are falling everywhere with Treasuries (-4bps) lagging the continent where European sovereigns have all seen 10-year yields decline by -6bps to -7bps.  It seems that there is growing hope the ECB will cut rates this Thursday, although according to the ECB’s own Watch Tool, the probability is just 2.7% of that happening.  

In the commodity space, oil is unchanged this morning as the variety of stories around leave no clear directional driver.  However, remember, it has bounced off recent lows despite production increases, and if confidence in economic growth is returning, which it seems to be, then I suspect the demand story will improve.  Meanwhile, metals markets (Au +0.65%, Ag +0.89%, Cu +1.1%, Pt +1.2%) are all having a good morning as a combination of dollar weakness and better economic sentiment are supporting the space.

As to the dollar, it is broadly lower against all its major counterparties apart from NOK (-0.2%) and INR (-0.2%) as NY walks in the door.  While the yen has been the biggest mover, the rest of the world has seen gains on the order of 0.35% or so uniformly.  The INR story apparently revolves around the trade talks with the US and concerns they may not be completed on time, but looking at the krone, after a strong rally last week following oil’s recovery, this morning looks like a bit of profit-taking there.

On the data front, there is very little coming out this week amid the summer holidays.

TodayLeading Indicators-0.2%
WednesdayExisting Home Sales4.01M
ThursdayECB Rate Decision2.00% (no change)
 Initial Claims228K
 Continuing Claims1952K
 Flash PMI Manufacturing52.5
 Flash PMI Services53.0
 New Home Sales650K
FridayDurable Goods-10.5%
 -ex Transport0.1%

Source: tradingeconomics.com

In addition to this limited calendar, it appears the FOMC is on vacation with only two speakers, Chairman Powell tomorrow morning and Governor Bowman tomorrow afternoon.  It is hard to get too excited about much in the way of market movement today.  As has been the case for the past six months, we are all awaiting the next White House Bingo call, as that is what is driving things for now.

Good luck

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Struggling…Juggling

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For users of Bloomberg worldwide
This morning, the service has died
So, traders are struggling
As it’s like they’re juggling
With one hand, behind their back, tied

 

While market activity continues, it seems that the single issue receiving the most attention today is that the Bloomberg professional service is not working almost anywhere in the world.  From what I have seen so far, there is no explanation other than technical problems, and on the Bloomberg website that I reference (the professional service is way too expensive for poets) the only mention has been oblique in the news that auctions in the UK and Europe have been extended in time until the service is operational again.  However, on X, the memes are wonderful.  I’m sure they will fix things shortly, and the financial world will go back to worrying about things like interest rates and equity valuations, but right now, this is the story!

JGB markets
Are garnering far more press
Than Ueda wants

 

Yesterday’s story about JGB yields continues to be a key market issue this morning, and likely will be so for some time to come.  Yields there continue to climb and as we all know, the fiscal situation in Japan has been tenuous at best.  The Japanese government debt/GDP ratio is somewhere around 263%.  Consider that when the US has been deemed the height of fiscal irresponsibility with a number half that high.  Granted, Japan is a net creditor nation, which is why they have been able to maintain this situation for so long, but as with every other situation where trends seem to go on forever, at some point they simply stop. 

Sourve: tradingeconomics.com

The thing that seemed to allow Japan to continue for so long was the fact that inflation there had remained quiescent, for decades.  It has been more than twenty years since official Japanese policy was to raise inflation.  Alas, to paraphrase HL Mencken, be careful what you wish for, you just may get it good and hard.  It appears that the good people of Japan are beginning to feel what it is like when a government achieves a policy goal after twenty years.  Notably, the key issue is that inflation, after literally decades of negative or near zero outcomes, has risen back to levels not seen since the early 1990’s, arguably two generations ago.  (The blip in 2014 was the result of the rise in Japan’s GST, their version of VAT, to 10%, which was a one-off impact on prices that dissipated within 12 months.)

This lack of inflation was deemed the fatal flaw in the Japanese economy, despite the fact that things there seem to work pretty well.  The infrastructure is continuously modernized and works well and while my understanding is that a part of the population was frustrated because their nominal incomes weren’t rising, with inflation averaging 0.0% or less for 20 years, they weren’t falling behind.  However, the broad macroeconomic view from policy analysts around the world was that Japan, a nation with an actual shrinking population, needed to do everything they could to push inflation higher in order to better the lives of its citizens.  Well, they have done so with inflation there now higher than the most recent readings in the US.  I fear that the good people of Japan are going to be asking many more questions about why the government thought this was a good idea as prices continue to rise.  It is already apparent in the approval numbers of the current government with readings on the order of 27%.

So, now we must ask, how will different markets interpret the ongoing rise in inflation.  We are already seeing what is happening in long-dated JGB markets, with the 30yr and 40yr yields rising to record levels, albeit below, and barely at current inflation readings respectively.  But, as I mentioned yesterday, the broader market question will be at what point will Japanese investors, who are one of the key sources of global capital, decide that the yield at home is sufficient to bring assets back from around the world, notably the US.  That level has not yet been reached although I suspect we are beginning to see the first signs of that.  

In the event this occurs, and I believe it will do so, what will be the impact on markets?  The first, and most obvious outcome will be a significant rise in the JPY (+0.6%).  As you can see below, while the yen has strengthened compared to levels seen in mid and late 2024, it remains far weaker than levels seen over the past 30+ years, where the average has been 112.62, more than 20% stronger than the current levels.

As to Treasury markets, Japan remains the largest non-US holder of Treasuries and while I doubt they will sell them aggressively, it would certainly be realistic to see them allow current positions to mature and not buy new ones but rather bring those funds home (stronger yen) while removing a key bid for the market (Kind of like their version of QT!).  Higher US yields are a real possibility here.  As to equities, these will likely be sold, although the Japanese proportion of holdings is not as large relative to others, but with rising yields and a falling dollar, it doesn’t feel like a good environment for equities.

Of course, all of this is dependent on the status quo in US policy remaining like it is today.  If President Trump can get Congress to implement his policies and they are successful at reinvigorating the US domestic economy, two big Ifs, these views will be subject to change.  The key to remember about markets, especially currency markets, is that there are two sides to every story, and expecting a particular outcome because one side of the equation moves may be quite disappointing if the other side moves and was unanticipated.

Ok, I spent far too long there, but not that much else is exciting.  The other story with some press has been driving oil markets higher (WTI +0.85%) with a gap up on news that Israel was considering a strike against Iranian nuclear facilities.  Naturally, this has been denied, and oil’s price has retreated from the early highs seen below.

Source: tradingeconomics.com

Sticking with commodities, gold (+0.5%) continues to rally, perhaps on fears of that Israeli news, or perhaps simply because more and more investors around the world want to own something they can hold onto and has maintained its value for millennia.

In the equity markets, yesterday’s modest US declines were followed by weakness in Japan (-0.6%) but strength in China (+0.5%) and Hong Kong (+0.6%).  As to the rest of the region, there were many more gainers (Korea, India, Taiwan, Australia) than laggards (Malaysia, Thailand) so a net positive tone.  In Europe, though, modest declines are the order of the day with the CAC (-0.5%) the worst performer and the FTSE 100 (-0.1%) the best.  US futures are also pointing lower at this hour (7:50) down on the order of -0.5% across the board.

Treasury yields (+4bps) have moved higher again this morning and have taken the entire government bond complex along with them as all European sovereign yields are higher by between 4bps (Germany, Netherlands) and 6bps (Switzerland, UK).  We have already discussed JGB yields where 10yr yields have moved higher by 2bps.

Finally, the dollar is softer across the board this morning with the DXY (-0.45%) a good proxy of what is happening.  The outliers are KRW (+1.2%) and NOK (+1.1%) with the latter an obvious beneficiary of oil’s rise while the former seems to be climbing in anticipation of something coming out of the G10 FinMin meeting in Canada this week.  Otherwise, that 0.45% move is a good proxy for most things.

On the data front, we have another day sans anything important although EIA oil inventories will be released with a solid draw expected.  Fed speakers were pretty consistent yesterday explaining that patience remains a virtue in a world where they have no idea what is going on.  Fed funds futures markets have pushed the probability of a June cut down to 5% and only 50bps are priced in for all of 2025.  (Personally, I see no reason that a cut is coming.)

The dollar remains on its back foot, and I expect that the combination of pressure from the Trump administration to keep it that way is all that is going to be necessary to see things continue with this trend.  Of course, an Israeli strike on Iran would change things dramatically in terms of risk perception and likely support the dollar, but absent that, right now, lower is still the call.

Good luck

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Positioned Quite Well

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The Fed is positioned quite well
To leave rates alone for a spell
Employment is stable
Which means they are able
To try, high inflation, to quell

 

“In discussing the outlook for monetary policy, participants observed that the Committee was well positioned to take time to assess the evolving outlook for economic activity, the labor market, and inflation, with the vast majority pointing to a still-restrictive policy stance. Participants indicated that, provided the economy remained near maximum employment, they would want to see further progress on inflation before making additional adjustments to the target range for the federal funds rate.”

I would say that this paragraph effectively summarizes the Fed’s views during the January FOMC meeting and based on the comments we have heard since, nothing has really changed much.  If anything, there appeared to be more concern over the upside risks to inflation than worries over a much weaker employment picture.  As well, there was some discussion regarding the potential of tariffs impacting prices and economic activity, although they would never be so crass as to actually use the word.

I would argue we don’t know anything more about their views now than we did prior to the Minutes.  Interestingly, they continue to believe that the current policy rate is restrictive even though Unemployment has been sliding, inflation is sticky on the high side and equity and other financial markets continue to make record highs.  Personally, I would have thought the appropriate view would be policy is slightly easy, but then I’m no PhD economist, just a poet.  If we learned anything it is that they are not about to change the way they view the world.  This merely tells me they have the opportunity to double down on previous mistakes.

It’s almost as if
Japanese markets now see
Future yen glory

Meanwhile, away from the machinations and procrastinations of the Fed, if we turn East, we can see that last night the yen, for a brief moment, traded through the key 150 psychological level, although it has since edged back higher.  This is the strongest the yen has been in more than two months and, in a way, is somewhat surprising given the strong belief that tariffs imposed against a nation will result in that nation’s currency declining.  But that is not the case right now, where despite mooted tariffs on steel, autos and semiconductors, three things the Japanese export to the US, the yen is climbing again.  

Source: tradingeconomics.com

One of the interesting things about the interest rate market’s response to the FOMC Minutes is that there continues to be an expectation of 39bps of rate cuts this year in the US.  But then, I read the Minutes as somewhat hawkish, obviously a misconception right now.  Meanwhile, in Tokyo, we continue to hear comments from former BOJ members that further rate hikes are coming and the futures market there is pricing 36bps of rate hikes by the end of this year.  So, for now, the direction of travel is diametrically opposed between the Fed and the BOJ.  Last night also saw JGB yields edge higher by another 1bp, to 1.43% and another new high level for this move.  Add it all up and the rate movements are sufficient to be the current FX drivers.

Now, as per my opening discussion regarding the Fed, while I believe that the next move should be a hike, and that gained support from a WSJ article this morning telling us to expect higher rent prices ahead which implies that the shelter portion of US inflation is not going to decline anytime soon, perhaps this is another reason to consider that the dollar may decline.  After all, the textbooks all explain that a high inflation economy results in a weaker currency.  If the Fed is truly going to continue to try to ‘normalize’ rates lower despite rising inflation, that will change my broad view of the dollar, and I suspect it will weaken dramatically.  While the yen is the first place to watch this given the opposing actions by the Fed and BOJ, it could easily spread.

Too, it is important to remember that while we have lately become accustomed to the yen trading in the 140-160 range vs. the dollar, for many years USDJPY traded between 100 and 120 as per the below chart.  While the world has certainly changed, it doesn’t mean that we cannot head back to those levels and spend another decade at 110 give or take a bit.

Source: tradingeconomics.com

Ok, with that in mind, let’s take a look at how markets have handled the new information.  Clearly US equity markets are not concerned about a Fed volte-face as they closed at yet new record highs yesterday, albeit with very modest gains of about 0.2%.  Asian markets, however, were not so sanguine with red the dominant color as the Nikkei (-1.25%) suffered amid that strengthening yen while both the Hang Seng (-1.6%) and mainland (CSI 300 -0.3%) fell despite PBOC promises of more support for the economy and the property market.  If I’m not mistaken, this is the third time the PBOC has said they will be increasing support for property markets and prices there continue to decline.  In fact, every major index in Asia fell overnight, mostly impacted by tariff fears.

Meanwhile, European bourses are all modestly firmer save the UK (-0.4%) as we see a rebound after yesterday’s declines and earnings data from Europe continues to show decent outcomes.  While there is much talk and angst over the Ukraine situation and tariffs, right now given the uncertainty of the timing of any tariffs, as well as the possibility that they may be delayed further or deals may be struck, investors seem to be laying low.  Remember, though, that European equity markets have been outperforming US markets for the past several months, although that could well be because their valuations had become so cheap, we are seeing a rotation into them for now.  As to the US markets, futures are pointing slightly lower at this hour (7:15) down about -0.25%.

In the bond market, yesterday saw Treasury yields cede their early gains and slip 2bps on the session and this morning they have fallen a further 2bps.  Meanwhile, European sovereign yields, after jumping yesterday across the board, are falling back slightly with declines on the order of -1bp or -2bps.

In the commodity market, the one constant is that the price of gold (+0.4%) continues to climb.  Whether it is because of growing global uncertainty, concerns over rising inflation, or technical questions regarding deliveries in NY, it is not clear.  Price action is not volatile, rather it has been a steady climb for more than a year.  just look at the chart below.

Source: tradingeconomics.com

As to the other metals, both silver and copper are also continuing their climb and higher by 1.0% this morning.  Oil (+0.2%) is also edging higher which seems a bit odd given the fundamental news I keep reading.  First, OPEC+ is going to begin increasing production later this year, second, the prospects of a peace deal with Russia seems likely to result in Russian oil coming back on the market sans sanctions, and third, despite talk of Chinese economic stimulus, demand from the Middle Kingdom has not been growing.  Add to this the fact that supply is expected to grow by upwards of 1mm bpd from Guyana, Brazil and Canada, and it seems a recipe for falling prices.  Just goes to show that markets are perverse.

Finally, the dollar is under pressure across the board this morning with the yen (+0.95%) leading the way but commodity currencies (AUD +0.5%, NZD +0.5%, ZAR +0.4%) also showing strength.  In fact, virtually every currency has strengthened vs. the greenback this morning.  Looking at the charts, there is a strong similarity across almost all currencies vs. the dollar and that is the dollar put in a peak back in early January and has been gradually declining since then.  This is true across disparate currencies as seen below and may well represent the market deciding that President Trump would like to see the dollar decline and will enact policies to achieve that end.  (I used USDDKK as a proxy for EURUSD since the two are linked quite closely with a correlation of about 0.99.)

Source: tradingeconomics.com 

As I wrote above, my strong dollar thesis is based on the Fed continuing to fight inflation.  If they abandon that fight, then the dollar will certainly decline!

On the data front, this morning brings Initial (exp 215K) and Continuing (1870K) Claims as well as the Philly Fed (20.0).  In addition to the Minutes yesterday we saw Housing Starts tumble although Permits were solid.  However, there is clearly some concern over the housing market writ large, with fewer first-time buyers able to afford a new home, hence the rent story above.  We have 3 more Fed speakers today but again, I ask, are they going to change their tune?  I don’t think so.  I find it hard to believe that the Fed will allow inflation to rebound sharply, but if they remain focused on rate cuts while inflation continues to creep higher, I fear that will be the outcome.  And that, as I said above, will be a large dollar negative.  We shall see.

Good luck

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A Fifth Wheel

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Confusion is clearly what reigns
As even the punditry strains
To understand whether
Investors will tether
Their future to stocks or take gains

 

As there was no activity in the US financial markets yesterday, it seems there was time for analysts to consider the current situation and make pronouncements as to investor behavior.  Ironically, we saw completely opposite conclusions from two major players.  On the one hand, BofA posted the following chart showing that investors’ cash holdings are at 15-year lows, implying they remain fully invested and quite bullish.

Meanwhile, the WSJ this morning has a lead article on how bearish investors are, claiming they are the most bearish since November 2023 according to the American Association of Individual Investors.  Apparently, 47.3% of investors surveyed believe stock prices will fall over the next 6 months.

So, which is it?  Are investors bullish or bearish?  To me this is a perfect description of the current situation.  Everyone is overloaded with information, much of which is contradictory, and so having a coherent view has become extremely difficult.  This is part and parcel of my view that the only thing we can clearly expect going forward is an increase in volatility.  In fact, someone said that Donald Trump is the avatar of volatility, and I think that is such an apt description.  Wherever he goes, mayhem follows.  Now, I also believe that people knew what they were voting for as change was in demand.  But for those of us who pay close attention to financial markets, it will take quite the effort to keep up with all the twists and turns.

Fed speakers are starting to feel
Like they have become a fifth wheel
So, let’s get prepared
For Fed speaking squared
As they work, their views, to reveal

Away from the conundrum above, the other noteworthy thing is that FOMC members are starting to feel left out of the conversation.  Prior to President Trump’s inauguration, market practitioners hung on their every word, and they apparently loved the power that came with that setting.  However, now virtually every story is about the President and his policies with monetary policy falling to a distant issue on almost all scorecards.  Clearly, for a group that had grown accustomed to moving markets with their words, this situation has been deemed unacceptable.  The solution, naturally, is to speak even more frequently, and I fear believe this is what we are going to see (or hear) going forward.  

Yesterday was a perfect example, where not only, on a holiday, did we have multiple speakers, but they actually proffered different messages.  From the hawkish side of the spectrum, Governor Michelle Bowman, the lone dissenter to the initial 50bp rate cut back in September, explained caution was the watchword when it comes to acting alongside President Trump’s mooted tariff and other policies, “It will be very important to have a better sense of these policies, how they will be implemented, and establish greater confidence about how the economy will respond in the coming weeks and months.”  That does not sound like someone ready to cut rates anytime soon.

Interestingly, from the dovish side of the spectrum, Governor Christopher Waller, an erstwhile hawk, explained in a speech in Australia (on the day the RBA cut rates by 25bps for their first cut of the cycle and ending an 18 month period of stable rates) that, “If this wintertime lull in progress [on inflation] is temporary, as it was last year, then further policy easing will be appropriate.”  I find it quite interesting that Governor Waller suddenly sounds so dovish as many had ascribed to him the intellectual heft amongst the governors.  This is especially so given that is not the message that Chairman Powell articulated either after the last meeting or at his Humphrey-Hawkins testimony recently.  

So, which is it?  Is the Fed staying hawkish or are they set for a turn?  That will be the crux of many decision-making processes going forward, not just in markets but also in businesses.  We will keep tabs going forward.

Ok, on to the market’s overnight performances.  Lacking a US equity market to follow, everybody was on their own last night which showed with the mixed results.  Japan (+0.25%) showed modest gains while the Hang Seng (+1.6%) rocketed higher on the belief that President Xi is going to be helping the economy, notably the tech firms in China, many of which are listed in Hong Kong.  Alas, the CSI 300 (-0.9%) didn’t get that memo with investors apparently still concerned over the Trump tariff situation.  Elsewhere in the region, Korea and Taiwan rallied while Australia lagged despite the rate cut.  In Europe, unchanged is the story of the day with most bourses just +/-0.1% different than yesterday’s close.  Right now, in Europe, the politicians are trying to figure out how to respond to the recent indication that the US is far less interested in Europe than in the past, and not paying close attention to financial issues.  As to the US, futures at this hour (7:25) are pointing higher with the NASDAQ leading the way, +0.5%.

In the bond market, yields are climbing led by Treasuries (+4bps) with most of Europe seeing yields edge higher by 1bp or 2bps as well.  Remember, yesterday European sovereign yields rose smartly across the board.  Also, I must note JGB yields (+4bps) which have made further new highs for the move and continue to rise.  It appears last night’s catalyst was a former BOJ member, Hiroshi Nakaso, explained he felt more rate hikes were coming with the terminal rate likely to be well above 1.0%.  While I believe the Fed will be cautious going forward, I still think they are focused on rate cuts for now.  With that in mind and the ongoing change in Japanese policy, I am increasingly comfortable with my new stance on the yen.

In the commodity markets, last Friday’s sell-off in the metals markets is just a bad memory with gold (+0.5%) rallying again and up more than 1% since Friday’s close.  I continue to believe those moves were positional and not fundamental.  Too, we are seeing gains in silver (+0.2%) and copper (+0.6%) to complete the triad.  Meanwhile, oil (-0.25%) continues to lag, holding above its recent lows but having a great deal of difficulty finding any buying impulse.  Whether that is due to a potential peace in Ukraine and the end of sanctions on Russian oil, or concerns over demand growth going forward is not clear to me, but the trend, as seen in the chart below, is clearly downward and has been so for the past year.

Source: tradingeconomics.com

Finally, in the FX markets, the dollar is firmer this morning rising against all its G10 counterparts with NZD (-0.6%) the laggard.  But losses of -0.2% are the norm this morning.  In the EMG bloc, we are seeing similar price behavior in most markets although MXN (+0.2%) is bucking the trend, seemingly benefitting from what appears to be a hawkish stance by Banxico and the still highly elevated interest rate differential in the peso’s favor.

On the data front, Empire State Manufacturing (exp -1.0) is the only data point although we will hear from two more Fed speakers, Daly and Barr.  I cannot believe that they have really changed their tune and expect that caution will remain their guiding principle for now, although I expect to hear that repeated ad nauseum as they try to regain their place in the spotlight.

Aside from my yen view, I still find it hard to be excited about many other currencies for now.  There is still no indication the Fed is going to move anytime soon, and other central banks are clearly in easing mode.  That bodes well for the dollar going forward.

Good luck

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Soaring Like Eagles

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Soaring like eagles
Japanese growth beats forecasts
Are rate hikes coming?

 

On this President’s Day holiday, when US markets are closed, arguably the most interesting financial story around is in the Land of the Rising Sun where Q4 GDP was released last night at 0.7%, significantly higher than forecast (0.2%) and Q3’s outcome (0.4%).  Japanese markets responded about as might be expected with the yen (+0.6%) rising alongside JGB yields (+3bps) with the 10yr now at 1.38%, its highest level since March 2010.  As to equity markets, the Nikkei (+0.1%) was caught between the positive GDP news and the stronger JPY.  Of course, much has been made of the BOJ’s overnight rate, which now sits at 0.50% after several hikes during the past year.  As well, expectations are for further hikes this year, with several analysts calling for a rate over 1.00% before the end of 2025.

But let us consider, for a moment, what the Japanese rate structure looks like in the context of the current inflation story in Japan.  As can be seen below, this is the current shape of the Japanese government bond yield curve, with 2yr yields at 0.80% while 30yr yields are up to 2.30%.

Source: Bloomberg.com

However, when looking at these yields, which as you can see from the column furthest to the right have risen substantially in the past 12 months, we must also remember the pace of inflation in Japan.  Since April 2022, every monthly CPI print in Japan has been above the target of 2.0%, with all but two of them above 2.5%.  In fact, as you can see from the chart below, the most recent data, as of December 2024 with the January data to be released Thursday night, shows the headline at 3.6%.  That is nearly three years of inflation data running above their target, yet the BOJ is unwilling to say inflation is stably at 2.0%.  I guess they are correct, it is stably at about 3.0%!

Source: tradingeconomics.com

But let’s add up this conundrum and perhaps we will better understand why GDP is growing so robustly in Japan.  If 10yr JGB yields are 1.38% and inflation is 3.60%, then real yields are running at… -2.22%.  That is a pretty loose monetary policy and one in which it is no surprise that economic activity is humming along.  In fact, unless we see a substantial decline in inflation, with no indication that is on the horizon, the BOJ has ample room to raise interest rates while maintaining accommodative monetary policy.

I know that there is much discussion regarding President Trump’s tariffs and whether Japan will be affected like other nations thus increasing uncertainty.  But the economic reality is that the BOJ remains highly stimulative to the economy which has been a driver of both economic growth and inflation.  I also know that this poet has been negative on the yen for a long time, in fact calling for USDJPY to reach 170 by the end of the year.  But as I observe the current situation, take into account the fact that President Trump very clearly wants the dollar to decline, and see more hints that the Japanese government is becoming more concerned over rising inflation in Japan, I am changing my tune here.  Add to these indications the fact that the yen, on any accounting, remains significantly undervalued, with estimates of as much as 50% (Big Mac Index claims it is 44% undervalued) and the case for yen strength is growing on me.

While over the past year, the yen has, net, done very little, the more recent trend is for yen strength as per the 1-month chart below.  My take is that we need to see a break below 150 before the fireworks start, but if that is the case, do not be surprised if we trade back to 130 before the year is over.

Source tradingeconomics.com

And really, that is the story of the evening.  The Chinese NPC will be meeting next week to discuss their economic plans and policies for the upcoming year, so that will be important.  As well, Europe has been put on notice by recent speeches from VP JD Vance and Secretary of State Marco Rubio that the relationship with the US is changing.  However, at this time, it is very difficult to discern if that means the euro will weaken further or rebound on increased internal activity.

Ok, let’s look at markets overnight.  It appears that with the US on holiday, many markets were reluctant to demonstrate leadership in any direction with not only Tokyo virtually unchanged, but the same being true throughout Asia (Hong Kong, 0.0%, China +0.2%, Australia -0.2%) and most of Europe with only the German DAX (+0.8%) showing any life at all.  It seems that several German defense contractors are benefitting from the idea that Europe may be increasing its defense expenditures locally.  US futures are little changed, although of course the market will not be open today.

Treasury bonds are also unchanged this morning with no trading but in Europe, yields are higher by between 3bps and 5bps, also on the rising defense expenditure story as there is an idea now floating around that there will be pan-European debt issuance to help fund that expenditure, thus adding supply to the market.  Certainly, despite the ECB maintaining a somewhat dovish stance, if European yields climb higher, that will likely support the single currency.

In the commodity markets, after Friday’s rout in the metals, where both precious and industrial metals sold off sharply, seemingly on no news, but more likely on position adjustments, this morning we are seeing a rebound, at least in gold (+0.5%) and silver (+0.6%) although copper (-1.3%) remains under pressure.  As to energy prices, oil (-0.35%) is continuing to hover closer to the bottom than top of its recent trading range as there is no clarity at all regarding how a potential Ukrainian peace will impact Russian production.  The one consistency is that European NatGas continues to decline on hopes that Russian gas deliveries will resume going forward.

Finally, the dollar is doing mixed this morning with the yen the outlier showing strength against the greenback, but ZAR (-0.5%) and MXN (-0.4%) showing weakness.  The rest of the G10 has seen only modest movement and that is generally true for the rest of the EMG bloc.  Traders remain highly uncertain over the future that President Trump will usher in.

On the data front, it is a pretty light calendar overall.

TuesdayEmpire State Manufacturing0.0
WednesdayHousing Starts1.4M
 Building Permits1.46M
 FOMC Minutes 
ThursdayInitial Claims215K
 Continuing Claims1860K
 Philly Fed16.3
 Leading Indicators-0.1%
FridayFlash Manufcturing PMI51.2
 Flash Services PMI53.2
 Existing Home Sales4.13M
 Michigan Sentiment67.8

Source: tradingeconomics.com

As well as this data, we see the EIA oil inventories and hear from 11 more Fed speakers.  But again, after Powell made clear they are on hold for now, and there has been no data to change that perception, and President Trump continues to dominate the spotlight, I don’t anticipate any new information here.

With the holiday today, I anticipate things will be quite slow.  Traders will take advantage of the time off to rest given the rising volatility we have seen.  Going forward, I will be reevaluating my longer-term views based potential changes in fiscal policies around the world.  But for now, other than the yen, I don’t see any clear changes yet.

Good luck

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Loathing and Fear

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On Friday, the jobs situation
Explained there was little causation
For loathing or fear
That later this year
Recession would soon drive deflation
 
Meanwhile, in the Super Bowl’s wake
The president’s set to forsake
Economists’ warning
That tariffs are scorning
Their views, and are quite a mistake

 

Let’s start with a brief recap of Friday’s employment report which was surprising on several outcomes.  While the headline was a touch softer than forecast, at 143K, revisions higher to the prior two months of >100K assuaged concerns and implied that the job market was still doing well.  You may recall that there were rumors of a much higher Unemployment Rate coming because of the annual BLS revisions regarding total jobs and population, but in fact, Unemployment fell to 4.0% despite an increase in the employed population of >2 million.  Generally, that must be seen as good news all around, even for the Fed because the fact that they have paused their rate cutting cycle doesn’t seem to be having any negative impacts.

Alas for Powell and friends, although a real positive for the rest of us, the Earnings data was much stronger than expected, up 0.5% on the month taking the annual result to a 4.1% increase.  Recall, one of Powell’s key concerns is non-core services inflation, and that is where wages have a big impact.  After this data, it becomes much harder to anticipate much in the way of rate cuts soon by the Fed.  This was made clear by the Fed funds futures market which is now pricing only an 8.5% probability of a rate cut in March, down from 14% prior to the data, and only 36bps of cuts all year, which is down about 12bps from before.

Securities markets didn’t love the data with both stocks and bonds declining in price, although commodities markets continue to rally alongside the dollar, a somewhat unusual outcome, but one that makes sense if you consider the issues.  Inflation is not yet dead, hurting bonds, while the fact the Fed is likely to remain on hold for longer supports the dollar.  Stocks, meanwhile, need to see more economic growth because lower rates won’t support them while commodities are seen as that inflation fighting haven.

Of course, it wouldn’t be a day ending in Y if we didn’t have another discussion on tariffs during this administration.  The word is that the president has two things in mind, first, reciprocal tariffs, meaning the US will simply match the tariff levels of other countries rather than maintaining their current, generally lower, tariff rates.  As an example, I believe the EU imposes a 10% tariff on US automobile imports, while the US only imposes a 2.5% tariff on European imports.  The latter will now rise to 10%.  It will be very interesting to see how the Europeans complain over the US enacting tariffs that are identical to their own.  

A side story that I recall from a G-20 meeting during Trump’s first term was that he offered to cut tariffs to 0% for France if they reciprocated and President Macron refused.  The point is that while there is a great deal of huffing and puffing about free trade and that Trump is wrecking the world’s trading relationships, the reality appears far different.  If I had to summarize most of the world’s view on trade it is, the US should never put tariffs on any other country so they can sell with reckless abandon, while the rest of the world can put any tariffs they want on US stuff to protect their home industries.  This is not to say tariffs are necessarily good or bad, just that perspective matters.

The other Trump tariffs to be announced are on steel and aluminum imports amounting to 25% of the value. This will be impactful for all manufacturing industries in the US, at least initially, so we will see how things progress.  Interestingly, the dollar has not responded much here because these are not country specific, so a broad rise in the dollar may not be an effective mitigant.

Ultimately, as I have been writing for a while, volatility is the one true change in things now compared to the previous administration.  Now, with that as backdrop, and as we look ahead to not only CPI data on Wednesday, but Chair Powell’s semi-annual congressional testimony on Tuesday at the Senate and Wednesday at the House, let’s look at how markets have responded to things.

As mentioned above, US equity markets fell about -1.0% on Friday after digesting the Unemployment data. However, the picture elsewhere, especially after these tariff discussions, was more mixed.  In Asia, Japanese shares were essentially unchanged although Hong Kong (+1.8%) was the big winner in the region.  But Chinese shares (+0.2%) did little, especially after news that the number of marriages in China fell to their lowest since at least 1986, another sign of the demographic decline in the nation.  Elsewhere in the region, there was more red (India, Taiwan, Australia) than green (Singapore).  European shares, though, are holding up well, with modest gains of about 0.2% – 0.4% across the board despite no real news.  US futures are also ticking higher at this hour (7:10), about 0.5% across the board.

In the bond market, Friday saw Treasury yields jump 6bps with smaller gains seen in Europe.  This morning, though, the market is far quieter with Treasury yields unchanged and European sovereigns similarly situated, with prices between -1bp and +1bp compared to Friday’s closing levels.  Of note, JGB yields have edged higher by 1bp and now sit at 1.31%, their highest level since April 2010.  With that in mind, though, perhaps a little bit of longer-term perspective is in order.  A look at the chart below shows 10-year JGB yields and USDJPY since 1970.  Two things to note are that they have largely moved in sync and that both spent many years above their current levels.  While it has been 15 years since JGB yields were this high, they are still remarkably low, even compared to their own history.  I know that many things have changed over that time driving fundamentals, but nonetheless, this cannot be ignored.

Source: tradingeconomics.com

Sticking with the dollar, it has begun to edge higher since I started writing this morning and sits about 0.2% stronger than Friday’s close.  USDJPY (+0.5%) is once again the leader in the G10, although weakness is widespread in that bloc.  In the EMG bloc, there were a few gainers overnight (INR +0.3%, KRW +0.3%) although the rest of the world is mostly struggling.  One interesting note is ZAR (0.0%) which appears to be caught between the massive rally in gold (to be discussed below) and the increased rhetoric about sanctions by the US in the wake of the ruling party’s ostensible call for a genocide of white South Africans to take over their property.  This has not been getting much mainstream media press, but it is clear that Mr Trump is aware, especially given that Elon Musk is South African by birth.  However, there is no confusion in the South African government bond market, which, as you can see below, has seen yields explode higher in the past week since this story started getting any press at all.

Source: tradingeconomics.com

Finally, the commodity markets continue to show significant movement, especially the metals markets.  Gold (+1.6%) is now over $2900/oz, another new all-time high and calling into question if this is just an arbitrage between London and New York deliveries.  Silver (+1.4%) continues to be along for the ride as is copper (+0.6%) which is the biggest gainer of the past week, up more than 7%.  Ironically, aluminum, the only metal where tariffs are involved, is actually a touch softer this morning.  As to oil (+1.2%) while the recent trend remains lower, it does appear to be bottoming, at least if we look at the chart below.

Source: tradingeconomics.com

Turning to the data this week, it will be quite important as CPI headlines, but we also see Retail Sales and other stuff and have lots of Fedspeak.

TuesdayNFIB Small Biz Optimism104.6
 Powell Testimony to Senate 
WednesdayCPI0.3% (2.9% Y/Y)
 -ex food & energy0.3% (3.1% Y/Y)
 Powell Testimony to House 
ThursdayPPI0.3% (3.4% Y/Y)
 -ex food & energy0.3% (3.3% Y/Y)
 Initial Claims216K
 Continuing Claims1875K
FridayRetail Sales-0.1%
 -ex autos0.3%
 IP0.2%
 Capacity Utilization77.7%

Source: tradingeconmics.com

In addition to Powell, we will hear from five more Fed speakers, although with Powell speaking, I imagine their words will largely be ignored.  Overall, the world continues to try to figure out how to deal with Trump and his dramatic policy changes from the last administration.  One thing to keep in mind is that so far, polls show a large majority of the nation remains in support of his actions so it would be a mistake to think that his policy set is going to be altered.  Net, the market continues to believe this will support the dollar, as will the fact that the Fed seems less and less likely to start cutting rates soon.  Keep that in mind as you consider your hedges going forward.

Good luck

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Is Past Prologue?

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The Japanese tale
Now sees brighter times ahead
Yen buyers rejoice

 

While its movement has been somewhat choppy, for the past month, the yen has been the best performing currency in the G10, gaining more than 3.0% during that time.  This strength seems to have been built on several different themes including a more hawkish BOJ, better growth prospects based on PMI data, rising wages, and some underlying risk aversion.  A quick look at the chart shows that the trend is clearly lower and there have been far more down days for the dollar than up days during this period.

Source: tradingeconomics.com 

Of course, as I regularly remind myself, and you my good readers, perspective is an important thing to keep in mind, especially when making statements about longer term prospects of a currency.  When looking at USDJPY over a longer term, say the past 5 years where long-term trends have been entrenched based on broad macroeconomic issues as well as the day-to-day vagaries of trading, the picture looks quite different.  In fact, as you can see from the below chart, the past month’s movement barely registers.

Source: tradingeconomics.com

My point is that we must be careful regarding the relative importance of information and news and keep in mind that short-term movements may very well be just that, short-term, rather than major changes in long-term trends.  The latter require very significant macro changes regarding interest rate policy and economic activity, at least when it comes to currencies, not simply a single central bank policy move.

So, the question at hand is, are we at the beginning of a major set of policy shifts that will change the long-term trajectory of the yen?  Or is the yen’s recent strength merely normal noise?

While almost everybody has their own opinion on how the Fed is going to proceed going forward, I think it is instructive to look at the Fed funds futures market and the pricing for future rate activity.  For instance, a look at the current market, especially when compared where these probabilities were one month ago tells us that expectations for Fed rate cuts have diminished pretty substantially, arguably implying that there is more reason to hold dollars.

Source: CME.org

You can see in the lower right-hand corner of the chart that the probability of a rate cut has fallen from nearly 44% to just 16.5% over the past month.  However, during that same period, the BOJ has not only raised interest rates by 25bps, but they have made clear that further rate hikes are coming based on wage settlements and sticky inflationary readings.  One potential way to incorporate this relative movement is to look at the change in forecast interest rates, which in the US have risen by ~7bps (27% *25bps) while Japanese interest rates have risen by 25bps with expectations for another 25bps coming soon.  That is a powerful incentive to be long yen or at least less short yen, than previous positioning.  And we have seen that play out as the yen has strengthened as per the above.

The real question is, can we expect this to continue?  Or have we seen the bulk of the movement?   Here, much will depend on the future of the Fed’s actions as the market is seeing a bifurcation between those who believe rates are destined to fall further once inflation starts to ease again, vs. those, like this poet, who believe that inflation is showing no signs of easing, and therefore the Fed will be hard-pressed to justify further rate cuts.  While I am not the last word on the BOJ, from every source I see, expecting their base rate to be raised above 1.00% anytime in the next several years is aggressive.  Just look at the below chart showing the history of the BOJ base rate.  The last time the rate was above 0.50%, its current level, was September 1995.  That is not to say they cannot raise it, just that as you can see, several times in the intervening years they tried to do so and were forced to reverse course as the economy fell back into the doldrums with inflation quickly falling as well.  

Source: tradingeconomics.com

Is past prologue?  Personally, my take is above 1.0% is highly unlikely any time in the next several years.  Meanwhile, if inflation remains the problem it is in the US, Fed cuts will be much harder to justify.  This is not to say that the yen cannot strengthen somewhat further, but I am not of the opinion we have had a sea change in the long-term trend.

Ok, after spending way too much time on the yen, given that there hasn’t even been any tariff discussion on Japanese products, let’s look elsewhere to see how things moved overnight.

Yesterday saw further relief by equity investors that tariffs are a key Trump negotiating tactic rather than an effort to raise revenue and US markets all gained, especially the NASDAQ.  However, the movement in Asia was more muted with the Nikkei (+0.1%) barely higher while both Hong Kong (-0.9%) and China (-0.6%) fell amid the Chinese tariffs remaining in place.  As to the regional markets, there were some notably gainers (Korea and Taiwan), but away from those two a more mixed picture with less absolute movement was the order of the day.  In Europe, Spain’s IBEX (+1.0%) is the standout performer after the PMI data showed only a modest slowing, and a much better result than the rest of the continent.  Perhaps this explains why the rest of the continent is +/- 0.2% on the session.  As to US futures, they are lower at this hour (7:30) on the back of weaker earnings data from Google after the close last night.

In the bond market, yields have fallen across the board (except in Japan where JGB yields made a run at 1.30%) with Treasury yields lower by 4bps this morning and 12bps from the highs seen yesterday morning.  European sovereign yields are all lower as well, between -4bps and -7bps, as the weaker PMI data has traders convinced that the ECB is going to respond to weakening growth rather than sticky inflation and are now pricing in 100bps of cuts this year with the first 25bps coming tomorrow.

In the commodity space, gold (+1.0%) is the god of commodities right now, rallying more than $100/oz over the past five sessions.  There continue to be questions as to whether this is a major short squeeze as COMEX contracts come up for delivery, but it is not hard to write a narrative that there is increased uncertainty in the world and gold is still seen as the ultimate safe haven.  This gold rally continues to pull other metals higher (Ag +0.8%, Cu +0.2%) although I have to believe this is going to come to a halt soon.  Meanwhile, energy prices have fallen again (oil -1.0%, NatGas -1.5%) as fears over supply issues have dissipated completely.

Finally, the dollar is under pressure overall, certainly one of the reasons the yen (+1.0%) has performed so well overnight, but elsewhere in the G10, we are seeing the euro, pound and Aussie all gain 0.4% or so.  In the EMG bloc, CLP (+1.0%) is gaining on that renewed copper strength while ZAR (+0.5%) is shaking off the Trump threats regarding recent legislative changes and benefitting from gold’s massive rally.  The one outlier is MXN (-0.4%) which seems to be caught between the benefits of stronger silver prices (Mexico is a major exporter of silver) and weaker oil prices.

On the data front today, we start with ADP Employment (exp 150K) then the Trade Balance (-$96.6B) and get ISM Services (54.3) at 10:00.  We also see the EIA oil inventory data with a modest build anticipated across all products.  Four more Fed speakers are on the docket but as we continue to hear from more and more of the FOMC, the word of the moment is caution, as in, the Fed needs to move with caution regarding any further rate cuts.

I don’t blame the Fed for being cautious as President Trump has the ability to completely change perspectives with a single announcement.  While yesterday was focused on Gaza, not really a financial market concern, who knows what today will bring?  It is for this reason that I repeatedly remind one and all, hedging is the best way to moderate changes in cash flows and earnings, and consistent programs, regardless of the situation on a particular day, are very valuable.

Good luck

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Will It Matter?

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Will Japan hike rates?
How much will it matter if
They do?  Or they don’t?

 

Market activity and discussion has been somewhat lacking this week as the real fireworks appear to be in Washington DC where President-elect Trump’s cabinet nominees are going through their hearings at the Senate.  Certainly, between that and the ongoing fires in LA, the news cycle is not very focused on financial markets in the US.  This, then, gives us a chance to gaze Eastward to the Land of the Rising Sun and discuss what is happening there.

You may recall yesterday I mentioned a speech by BOJ Deputy Governor Himino where he explained that given the inflation situation as well as the indication that wages would continue to rise at a more robust clip in Japan, a rate hike may be appropriate.  Well, last night, Governor Ueda basically told us the same thing.  Alas, it seems that the BOJ takes a full day to translate speeches into English because there are no quotes from Ueda, but we now have the entire Himino speech from the day before.

Regardless, the essence of the story is that the BOJ is carefully watching the data and awaiting the Trump inauguration to see if there are any surprise tariff outcomes against Japan (something that has not been discussed) while they await their own meeting at the end of next week.  Market pricing now has a 72% probability of a 25bp rate hike next week, up from about 60% yesterday, and last night the yen did rally, climbing 0.7%.  However, a quick look at the chart below might indicate that the market is not overly concerned about a major yen revaluation.

Source: tradingeconomics.com

In fact, since the last BOJ meeting in December, when they sounded a bit more dovish than anticipated, the yen has done very little overall, treading water between 156.50 and 158.50.  While a BOJ rate hike would likely support the yen somewhat, there is another dynamic playing out that would likely have the opposite effect.  At the beginning of the year I prognosticated that the Fed may well hike rates by the end of 2025 as inflation seems unlikely to cooperate with their prayers belief that 2.0% was baked in the cake.  At the time, that was not a widely held view.  However, in a remarkably short period of time, market participants are starting to discuss the idea that may, in fact, be the case.  Even the WSJ today had a piece on the subject from James Mackintosh, one of their economics writers laying out the case.  The point here is that if tighter monetary policy by the Fed is in the cards, I suspect the yen will have a great deal of difficulty climbing much further.  Let’s keep an eye on the 156.00 level for clues that things are changing.

In England, inflation is rising
Less quickly than some theorizing
Meanwhile in the States
Jay and his teammates
Are hoping for data downsizing

Turning now to the inflation story, European releases were generally right on forecast except for the UK, where the headline rate fell to 2.5% while the core fell to 3.2%, 1 tick and 2 ticks lower than expected respectively.  Certainly, that is good news for the beleaguered people in the UK and it has now increased the odds that the BOE cuts rates at their next meeting on February 6th.  However, we cannot forget that the BOE’s inflation target, like that of the Fed, is 2.0%, and there is still limited belief that they will achieve that level even in 2025. But the markets did respond to the data with the FTSE 100 (+0.75%) leading the European bourses higher while 10-year Gilt yields (-8bps) have seen their largest decline in several weeks and are also leading European sovereign yields lower.  Interestingly, the pound has been left out of this movement as it is essentially unchanged on the day.  Perhaps there is a message there.

Which brings us to the US CPI data this morning.  after yesterday’s PPI data printed softer than expected at both the headline and core levels, excitement is building for a soft print and the resumption of the Fed cutting cycle.  However, it is important to remember that despite the concept that these prices should move together, the reality is they really don’t.  Looking at the monthly core movements below, while the sign is generally the same, the relationship is far weaker than one might imagine.

Source: tradingeconomics.com

In fact, since January 2000, the correlation between the two headline series is 0.04%, or arguably no relationship at all.  I would not count on a soft CPI print this morning based on yesterday’s PPI.  Rather, I am far more concerned that the ISM Services Prices Paid index last week was so hot at 64.1, a better indicator that inflation remains sticky.  But I guess we will all learn in an hour or two how it plays out.

Ahead of that, let’s look at the rest of the overnight session.  Yesterday’s mixed US equity performance (the NASDAQ lagged) was followed by mixed price action overnight with the Nikkei (-0.1%) edging lower on the modestly stronger yen and talk of a rate hike, while the Hang Seng (+0.3%) managed a gain on the back of Chinese central bank activity as the PBOC added more than $130 billion in liquidity ahead of the Lunar New Year holiday upcoming.  However, mainland shares (CSI 300 -0.6%) did not share the Hong Kong view.  Elsewhere in the region Taiwan (-1.25%) was the laggard while Indonesia (+1.8%) jumped on a surprise rate cut by the central bank there.

In Europe, though, all is green as gains of 0.4% (CAC) to 0.8% (DAX) have been driven by ECB comments that rate cuts are coming as concerns grow over the weakness of the economies there.  Germany released its GDP data and in 2024, Germany’s GDP shrank by -0.2%, the second consecutive annual decline and the truth is, given the combination of their insane energy policy and the fact that China is eating their proverbial lunch with respect to manufacturing, especially in the auto sector, it is hard to look ahead and see any positivity at all.  Meanwhile, US futures are higher by 0.5% or so at this hour (7:00) clearly with traders looking for a soft CPI print.

In the bond market, Treasury yields are lower by 3bps this morning but remain just below 4.80% and the 5.0% watch parties are still hot tickets.  European yields have also softened away from Gilts, with the entire continent lower by between -2bps and -4bps.  Right now, with dreams of a soft CPI, bond bulls are active.  We shall see how that plays out.

In the commodity space, oil (+0.3%) is modestly firmer after a reactionary sell-off yesterday.  The IEA modestly raised its demand forecast and supplies in the US, according to the API, were a bit tighter yesterday, so that seems to be the support.  NatGas is little changed right now while metals markets (Au +0.4%, Ag +0.5%, Cu +0.4%) are edging higher although mostly remain in a trading range lately.  Activity here has been lackluster with no new story to drive either direction.

Finally, the dollar is a touch softer overall, but away from USDJPY, most movement is of the 0.1% variety. Right now, the FX markets are not garnering much interest overall.

On the data front, expectations for CPI are as follows: Headline (0.3%, 2.9% Y/Y) and Core (0.2%, 3.3% Y/Y).  As well, we see Empire State Manufacturing (3.0) and then the Beige Book at 2:00pm.  We also have three Fed speakers, Williams, Kashkari and Barkin, but are they really going to alter the cautionary message?  I doubt it and the market continues to price a single 25bp cut for all of 2025.  The real fireworks will only come if/when price hikes start to get priced in as discussed above.

It is hard to get excited for market activity today as all eyes remain on the confirmation hearings and LA.  As such, I suspect there will be very little to see today.

Good luck

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Falling Further

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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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A New Denouement

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The story is that the Chinese
Will speed up their policy ease
Creating for Yuan
A new denouement
Of currency weakness disease
 
Their problem is that in the past
That weakness could happen too fast
So, how far will Xi
Be willing to see
Renminbi decline at long last?

 

As we await the US CPI data this morning, the story du jour in markets revolves around the Chinese renminbi and whether President Xi will allow, or encourage, the PBOC to weaken the currency.  Strategically, Xi has made a big deal to the rest of the world that the Chinese currency will remain strong and stable as he seeks other nations to increase their use of the renminbi in commercial transactions as well as a store of value.  I believe part of this is a legitimate goal but that there is also a significant fear underlying these actions as history has shown the Chinese people will flee the currency if it starts to weaken too quickly.  It is the latter issue that has been the primary driver of the PBOC’s efforts to continuously fix the renminbi at stronger than market levels.
 
This process worked well enough for the past four years as the Biden administration, while certainly not friendly to China, was not aggressively attacking the nation’s efforts to expand its influence.  However, that situation is about to change with the Trump administration and as Mr Trump has already threatened numerous new tariffs on various parts of China’s production economy, Xi’s calculus must change.  This puts Xi in a difficult situation; allow the currency to weaken more aggressively to offset the impact of any tariffs and suffer through capital flight or maintain the renminbi’s value and see exports decline along with overall economic activity.  It is easy to see in the chart below when the story about allowing a weaker currency hit the tape.  However, there is not nearly enough information to take a longer-term view on the subject.

 

Source: tradingeconomics.com

One other thing to remember is that Chinese interest rates are continuing to decline with 10-year yields trading to yet another new low last night at 1.88%.  As the spread between US and Chinese yields continues to widen, by itself that will put pressure on the renminbi to decline.  The problem for Xi is that no matter the control the PBOC has over the FX markets in China, now that there is an offshore market, if the Chinese people become concerned over the value of the renminbi, it has the ability to decline far more quickly than the government would want to allow.

For those of you with Chinese assets on your balance sheet or Chinese denominated revenues, I would be looking to maximize my hedges for now.  As an aside, there were a number of forecast changes by major banks overnight with many calls for USDCNY to reach 7.50 or higher by the end of next year now.

The market’s convinced
A rate hike is on the way
Why won’t the yen rise?

The other story overnight focused on Japan, or more precisely the BOJ meeting to be held in one week’s time.  It seems that there is a lot of dissent amongst the analyst community regarding whether or not the BOJ will hike rates.  As an example of how thin all the analyst gruel really is, one of the key rationales for the belief in a rate hike was that last week, Toyoaki Nakamura, perceived as the most dovish BOJ board member, indicated he didn’t object to a rate hike, although wanted to see more data before declaring one was appropriate for December.  However, just last night the BOJ added a speech and press briefing to their calendar for Deputy Governor Ryozo Himino right before the January meeting.  This has the punditry now expecting the BOJ to wait until then rather than move next week.  The below chart shows the change in the market’s expectations for a rate hike over the past week.

As I said, the tea leaves that the punditry are reading really don’t say very much at all.  Perhaps we can look at the economic data to get a sense.  Over the past month, we have seen CPI for both the nation and Tokyo print higher than forecast and continue to slowly climb.  As well, PPI printed higher and GDP continues to grow, albeit at a modest pace.  Of greater concern is that earnings data is lagging the CPI data.  

A look at the FX market would indicate that traders are losing their taste for a rate hike next week, at least as evidenced by the yen’s recent weakness.  As you can see in the past week, it has slipped nearly 2%, hardly a sign that higher Japanese rates are expected.  But something that is not getting much press is the potential Trump impact, where the incoming president would like to see the yen, specifically, strengthen as it is truly historically undervalued.  FWIW, which is probably not that much, I am in the rate hike camp for next week and expect the yen will find some support soon.

Source: tradingeconomics.com

Ok, enough Asian currency talk.  Let’s see how everything else behaved ahead of this morning’s data.  Yesterday’s modest US equity declines were followed by virtually no movement in Japanese shares although most of the rest of Asia followed the US lower.  Hong Kong (-0.8%) and Taiwan (-1.0%) were the worst performers and the one outlier the other way was Korea (+1.0%) as the KOSPI continues to recoup the losses made after the martial law fiasco.  European bourses are mostly little changed on the day with Spain’s IBEX (-1.1%) the lone exception which has been negatively impacted by Q3 results from Inditex (the parent company of Zara).  As to US futures, at this hour (7:25) they are little changed.

In the bond market, yields continue to edge higher in Treasuries (+2bps) and European sovereigns with gains on the order of 1bp to 2bps across the board.  While there is some discussion regarding fiscal questions in Europe, ultimately, nothing has broken the connection between US and European yields, and I would contend they are all awaiting this morning’s CPI.

In the commodity markets, oil (+1.4%) is rebounding although remains below $70/bbl, which seems to be a trading pivot for now.  The China stimulus story remains the key in the market with a growing belief that if China does successfully stimulate, oil demand will increase.  Meanwhile in the metals markets, gold is unchanged this morning after another nice rally yesterday while both silver and copper are under modest pressure.  I would contend, however, that the trend for all metals remains slightly upward.

Finally, the dollar is firmer against virtually all its counterparts this morning with most G10 currencies softer on the order of -0.3% or so although CAD and CHF are little changed on the session.  In the EMG bloc, KRW (+0.3%) is rebounding alongside the KOSPI as the excesses from the martial law story last week continue to be unwound, but elsewhere in the bloc, modest weakness, between -0.2% and -0.4%, is the rule.  However, this is all dollar focused today.

On the data front, it is worth noting that yesterday’s NFIB Small Business Optimism Index shot higher in November in the wake of the election results, heading back toward its long-term average just above 100.  As to this morning, forecasts for Headline (exp 0.3%, 2.7% Y/Y) and Core (0.3%, 3.3% Y/Y) CPI continue to indicate that the Fed may be overstating the case in their belief that inflation pressures are ebbing.  Rather, I continue to believe that we have seen the bottom in the rate of inflation and a gradual increase is in our future.  Two other things of note are the BOC rate decision (exp 50bps cut) this morning and then the Brazilian Central Bank rate decision (exp 75bp HIKE) this afternoon.  The latter is clearly an attempt to rein in the BRL’s recent dramatic decline.

With no Fed speakers, if the data this morning is significantly different than expectations, I would look for the Fed Whisperer, Nick Timiraos, to publish something before the end of the day in order to get the Fed’s latest views into the market.  Absent that, nothing has gotten in the way of the higher dollar at this stage so stay sharp.

Good luck

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