Tag Archives: #JPY

Looking Elsewhere

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The Middle East story is back
With fears that Iran might attack
So, oil is rising
And it’s not surprising
The dollar is leading the pack
 
But til anything happens there
The market is looking elsewhere
The Payrolls report
May well be the sort
That causes Chair Powell to care

 

It was only a week ago when the Israeli response to the Iranian missile barrage was seen by market participants as a clear de-escalation of tensions in the Middle East.  The market’s response was to reduce the risk premium in the price of oil which promptly fell $5/bbl amid signs of slowing growth in China as well.  Alas, as can be seen in the chart below, that was Monday’s story and no longer pertains.  Rather, the new concern is that Iran is planning to launch yet another attack, this time via proxies in Iraq, with Israel vowing to respond more severely.  You cannot be surprised that oil has regained its levels prior to Monday’s narrative.

Source: tradingeconomics.com

Adding to the buying pressure for oil has been the better than expected growth data from China (Caixin Mfg PMI printing better than expected 50.3) and solid US GDP data on Wednesday along with stronger Personal Income and Spending data yesterday.  And remember, the market is also looking ahead to the Standing Committee of the National People’s Congress in China to add significant fiscal stimulus there, with CNY 10 trillion (~$1.4 trillion) the most popular number being bandied about.  If that comes to pass, it will seemingly increase demand for oil on China’s part.

Of course, there is another piece of news that the market is awaiting with the potential for a significant impact, today’s Employment Report.  Ahead of the release, these are the current consensus forecasts:

Nonfarm Payrolls113K
Private Payrolls90K
Manufacturing Payrolls-28K
Unemployment Rate4.1%
Average Hourly Earnings0.3% (4.0% Y/Y)
Average Weekly Hours34.2
Participation Rate62.5%
ISM Manufacturing47.6
ISM Prices Paid48.5

Source: tradingeconomics.com

You may remember that last month, the NFP number printed much higher than expected at 233K which began the questioning of the Fed’s expected rate cutting path.  Frankly, the data since then has done very little to argue for much policy ease as Retail Sales have held up, GDP was solid and prices appear to be moving higher, not lower.  In fact, you can see how things have played out over the past month in the chart/table below from the CME showing the market priced probability of future Fed funds rates.  Check out where things were a month ago, just prior to the last NFP report.

The market was pricing a more than 50% probability of at least 75 basis points of rate cuts by December. Obviously, that is no longer the case and if this morning’s data proves stronger than forecast (remember, ADP Employment was significantly stronger than expected) many more people are going to call into question the assumption that the Fed is going to be cutting rates at all.  If you think about it, GDP is growing above trend at 2.8%, inflation remains above target with core CPI 3.3% and Unemployment is at a still historically low 4.1%.  if I look at those three major economic guideposts, the one that stands out to be addressed is inflation, not Unemployment, and that takes tighter policy.

Now, maybe this morning’s data will be awful, with a 50K NFP print and a jump in the UR to 4.3%.  That would certainly bring the doves out more aggressively but absent something like that, I continue to scratch my head as to why the Fed is so keen to cut the Fed funds rate.  Let’s put it this way, if the data surprises to the upside, I expect the December rate cut probability to fall close to 50%.

At any rate, those are the topics du jour, away from the election stories that are suffocating most everything else.  So, let’s see how things behaved overnight.

Well, I guess there has been one other story that has gotten tongues wagging, the fact that US equity markets had their worst session in two months with all three major indices falling sharply.  This was blamed on weaker than forecast earnings releases from several companies in the tech sector, where even if the actual earnings were solid, there were other issues like guidance or breakdowns of revenues, that disappointed.  It is far too early to declare that the love affair with the tech sector, especially AI, is ending, but there are a few names in the sector that are suffering greatly.  This certainly bears close watch going forward, because if this theme starts to lose adherents, even in the short run, it appears there is ample room for a move lower in stocks.

Turning to other markets overnight, Tokyo (-2.6%) led the way lower in Asia with most regional exchanges falling and only Hong Kong (+0.9%) bucking the trend.  There are those who believe there is a causal relationship between the Nikkei, the NASDAQ and USDJPY with one theory that it is the FX rate that drives these movements.  While it is certainly true that we have seen correlation amongst these three markets, I find it difficult to make the case that USDJPY is the driver.   A quick look at all three on the same chart certainly shows that they regularly move in similar directions, but I have a harder time claiming which one is the leader.

Source: tradingeconomics.com

However, despite the negativity from yesterday’s US moves and the overnight sell-off and the sharp rise in oil prices, European bourses are all in the green today, higher by about 0.5% across the board.  In fact, this is in sync with US futures which are also trading higher, by about 0.4%, this morning.

In the bond market, other than UK Gilt yields, which rose 7bps net yesterday although traded as high as 20bps higher than Wednesday’s close during the session, the rest of the bond markets were quiet.  It seems that UK bond investors are not that happy with the recently promulgated budget, and neither are voters as there was a by-election in a “safe” Labour seat that went to Nigel Farage’s Reform UK party.  I have a feeling that bond markets are going to be the epicenter of market activity over the next week or two as huge differences of opinion remain regarding the potential outcomes of the US election.

Away from oil (+1.9%) this morning, the rest of the commodity sector is also doing well today with both precious and base metals all in the green.  But they have not recouped yesterday’s declines which saw gold fall back -1.5% with even larger losses in silver (-3.2%) although copper (-0.6%) didn’t have nearly as bad a day.  This morning, the metals are higher by between 0.2% (gold ) and 0.6% (silver), so it seems like it was a month-end position adjustment and profit-taking exercise.

Finally, the dollar is strong this morning, rallying against most of its G10 counterparts with JPY (-0.4%) the laggard while the pound (+0.1%) seems to be benefitting from higher yields.  Versus the EMG bloc, the dollar is also broadly higher with only MXN (+0.2%) showing any life.  The peso has a number of issues ongoing with concerns that a Trump victory may lead to tariff increases and strain on the economy while domestic issues have arisen over the potential resignation of eight of their Supreme Court Justices which will have a big impact on the judicial system and potentially the Morena party’s ability to rule effectively.  However, after a steady weakening of the peso throughout October, it appears we are seeing a bit of a bounce this morning.

And that’s really what we have today.  At this point, we will all await the NFP and respond accordingly.  Something to keep in mind is that the hurricanes last month could well impact the data, so whatever the outcome, you can be sure that there will be those saying to ignore it as incomplete.  Regarding the dollar, it is still hard to bet against in my mind given the US economic data continues to be the best around.

Good luck and good weekend

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Full Throat

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The news cycle’s still ‘bout the vote
With Harris and Trump in full throat
‘Bout why each should be
The one filled with glee
When voters, to prez, they promote
 
Meanwhile, out of China we hear
More stimulus is coming near
The rumor is on
That ten trillion yuan
Is how much Xi’ll spend through next year

 

The presidential election continues to be the primary source of news stories and will likely remain that way until a winner is decided.  The vitriol has increased on both sides, and that is unlikely to stop, even after the election as neither side can seem to countenance the other’s views on so many subjects.  

As we watch Treasury yields continue to rise, many are ascribing this move to the recent polls that show former President Trump gaining an advantage.  The thesis seems to be that his proffered plans will increase the budget deficit by more than Harris’s proffered plans, but I find all this a bit premature as budget deficits are created by Congress, not presidents, so the outcome there will have a significant impact on the budget.  With that in mind, though, if we continue to see the yield curve steepen as long-end rates rise, my take is the dollar will continue to perform well.

But the election is still a week away and while there is no new data of note today, we do see important numbers starting tomorrow.  In the meantime, one of the big stories is that the Chinese National People’s Congress is now considering a total stimulus package of CNY 10 Trillion to help support the economy, and that if Trump wins, that number may grow larger under the assumption that he will make things more difficult for the nation.  This report from Reuters indicates that there would be a lot of new debt issuance to help support local governments repay their current borrowings as well as support the property market.  

Now, this is very similar to what was reported last week, although the totals are larger, but there is nothing in the story indicating that President Xi is going to give money to citizens, nor focus on new production.  This all appears to be an attempt to clean up the property market mess (remember, most local government debt problems are a result of the property debacle as well), which while necessary is not sufficient to get China back to its pre-pandemic growth trend.

As it happens, this story did not print until after the Chinese equity markets closed onshore, so the CSI 300’s decline of -1.0% has been reversed in the futures aftermarket.  As well, given that Hong Kong’s market doesn’t close until one hour later, it had the opportunity to rebound before the close and finished higher on the day by 0.5%.  As to the rest of Asia, it mostly followed the US rally from yesterday with the Nikkei (+0.8%) performing well and gains seen across virtually all the other markets there.

Turning to Europe, the only data of note was the German GfK Consumer Confidence index which rose to -18.3.  While this was better than last month and better than expected, a little perspective is in order.  Here is the series over the past ten years.

Source: tradingeconomics.com

While it seems clear that consumers are feeling a bit more confident than they have in the past year, ever since the pandemic, the German consumer has been one unhappy group!  And the other story from Germany this morning helps explain their unhappiness.  VW is set to close at least 3 factories and reduce wages by 10% as they try to compete more effectively with Chinese EV’s.  I can only imagine how confident that will make the people of Germany!

Now, the interesting thing about confidence is that while it offers a view of the overall sentiment in markets, it doesn’t really correlate to any specific market moves.  For instance, the euro (-0.2%) remains rangebound albeit slightly lower this morning, while the DAX (+0.25%) has actually rallied a bit, although that is likely on the basis of the VW news helping to convince the ECB that they need to cut rates further and faster.  In fact, most European bourses are firmer this morning on the lower rate thesis I believe, although Spain’s IBEX (-0.25%) is lagging after some moderately worse earnings news from local companies.

Turning to the commodities sector, it should be no surprise that they are higher across the board as the combination of proposed Chinese stimulus and potential future inflation in the US based on a possible Trump victory (although there is nothing in the Harris policies that seem likely to reduce inflation) means that commodities remain a favored outlet for investors.  After a couple of days of choppiness, we are seeing oil (+1.2%) rise nicely (perhaps the decline was a bit overdone on position adjustments) and the metals complex rise as well (Au +0.3%, Ag +1.3%, Cu +1.1%) as all three will benefit from all the new spending that is likely to occur in the US as well as China.  

One other thing to note, which disappointed the gold bulls, as well as the dollar bears, is that the BRICS meeting in Kazan, Russia resulted in…nothing at all regarding a new currency to ‘challenge’ the dollar.  Toward the bottom of their proclamation, they indicated they would continue to look for ways to work more closely together, but there is nothing concrete on this subject.  As I have been writing for the past several years, and paraphrasing Mark Twain, rumors of the dollar’s demise have been greatly exaggerated.  So, there will be no BRICS currency backed by gold or anything else, no new payment rails and Treasuries are going to remain the haven asset of choice alongside gold.

As to the dollar vs. its other fiat counterparts, it is a bit stronger this morning alongside US yields (Treasuries +3bps) with even the commodity bloc having difficulty gaining ground.  Of note is USDJPY, which is higher by 0.35% and now firmly above 153.00.  Last night, we did hear our first bout of verbal concern from a MOF spokesman explaining they are watching the yen carefully.  I’m sure they are, but I believe they will be very reluctant to enter the market when US yields are rising, and the BOJ is not keeping pace.  In fact, while the November rate cut is baked in at this point, the probability of the Fed cutting in December continues to slowly decrease (now 71%).  If we see a good NFP number Friday, I would look for that to decrease more rapidly and the dollar to see another leg higher.

And that’s all the market stuff today.  On the data front, Case Shiller Home Prices (exp 5.1%) and the JOLTS Job Openings data (7.99M) are the major releases.  As well, the Treasury is auctioning 7-year Notes this morning after a tepid 2-year auction yesterday.  It is very possible investors are starting to get a bit nervous about the US fiscal situation and if that continues, the irony is that higher yields will beget a higher dollar despite the concerns.

It is difficult to get away from the election impact on markets, and it seems that as momentum for Trump builds, the market is going to continue to push yields and stocks higher with the dollar gaining ground alongside gold.  Go figure.

Good luck

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Surprise!

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

 

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

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

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

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

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

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

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

Source: tradingeconomics.com

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

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

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

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

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

Source: tradingeconomics.com

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

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

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

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

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

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

Good luck

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More Money to Mint

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As an eagle soars
So too did the yen after
Ishiba-san won

 

Political change in Japan is far less bombastic and exciting than here in the US as evidenced by the election of Shigeru Ishiba as the new leader of the Liberal Democratic Party (LDP) last night.  Given the LDP’s large majority in the Diet (Japan’s parliament), as the new leader, Ishiba-san is now all but certain to be the new Prime Minister. This will likely be confirmed by a vote as early as next Tuesday, but sometime very soon regardless.

Ishiba’s background, a party veteran and former defense minister, seems to have been the right focus at the right time as strains with China have recently increased and the electorate (LDP members, not the general population) are clearly hearing about security concerns more than other issues.  The implication is that economic issues were not the driving force here, but in that vein, Ishiba’s views appear to be to allow the BOJ and Governor Ueda to continue their normalization process, finally ending the decade plus of Abenomics that worked to raise inflation.  

Now, as it happens, last night Tokyo inflation was released with the headline falling to 2.2% and the core falling to 2.0%, as expected.  It also appears that one of his key opponents, Sanae Takaichi, had been an advocate of pressuring the BOJ to slow its policy normalization, so with the results, market participants reacted swiftly, and the yen rallied sharply on the news as per the below chart while the Nikkei after an initial sharp decline, rebounded and closed higher by 2.3%.

Source: tradingeconomics.com

Going forward, it seems unlikely that the yen is going to be a focus of the new Ishiba administration.  Rather, he is clearly focused on defense strategy so Ueda-san will be able to continue his normalization efforts at his own pace.  As evidence, JGB yields stopped their recent slide and backed up 2bps overnight.  I suspect that we will see a very gradual move higher here with key drivers to be purely economic issues rather than political ones, at least for a while.

This morning, the PCE print
Will help give another key hint
To whether the Fed
When looking ahead
Will soon start, more money, to mint

The other story for the day is the PCE report to be released at 8:30. Current expectations are for a 0.1% M/M, 2.3% Y/Y rise in the headline number and a 0.2% M/M, 2.7% Y/Y rise in the ex-food & energy reading.  If these are the realized outcomes, the trend lower in inflation will remain on track and all the Fed speakers will feel vindicated that the 50bp cut last week was appropriate.  But I think it is worthwhile to take a quick look at a chart of how this number (core PCE) has evolved over time to help us better understand where things are in relation to the pre-pandemic economy. 

Source: tradingeconomics.com

Now, while there is no doubt that we are well below the highest levels seen two years ago, it is not difficult to look at this chart and see a potential basing formation, well above the pre-pandemic levels.  In fact, today’s expectations on the core reading are for a bounce higher of 0.1% which would only reinforce the idea that we have seen the bottom in this reading.  Of course, any one month’s data is not definitive as everything is subject to revisions, and simply looking at the chart, it is easy to see both ebbs and flows in the data well before the pandemic.  But I continue to be concerned that the Fed’s very clear ‘mission accomplished’ attitude on inflation is a big mistake that will come back to haunt us all sooner than you think.

Ahead of the data, a look at the overnight session shows that the ongoing rally in risk assets that started with the Fed and has been goosed by China’s efforts this week, remains the dominant theme.  In fact, Chinese shares had another gargantuan session last night (CSI 300 +4.5%, Hang Seng +3.6%) as hedge funds who had been quite short the Chinese stock market prior to the announcements this week continue to scramble to cover those shorts as well as get long for the rest of the expected ride.  But away from China and Japan, the rest of Asia was far less excited with declines seen in India, Korea and Australia leading most indices lower there.  As to European bourses, they are firmer this morning led by the DAX (+0.8%) but green everywhere after preliminary inflation data for September from France and Spain saw declines well below expectations to 1.5% and investors increased the probability of an October ECB rate cut substantially.  While some ECB members remain concerned over the stickiness of services prices, which continue to hover above 4%, if the headline numbers are falling below 2%, I think it will be very difficult for Madame Lagarde to push back against another cut next month.  Meanwhile, ahead of the data, US futures are unchanged.

In the bond market, Treasury yields have edged lower by 1bp while European sovereign yields have moved a similar amount except for French OATs which have slipped 3bps.  The story about French debt yielding more than Spain, one of the original PIGS has gotten a lot of press and it seems deeper thinkers disagree with the idea and are buying ‘undervalued’ French OATs.  

In the commodity markets, oil (+0.15%) has finally stopped falling, at least for the moment, although the recent trend is anything but encouraging for oil bulls.  Crude is lower by -4.5% in the past week and -9.0% in the past month, clearly helping the headline inflation readings.  As to the metals markets, after another strong day yesterday, they are consolidating with very modest declines (Au -0.2%, Ag -0.1%, Cu -0.4%) although the trend in all three remains firmly higher.

Finally, the dollar, after several sessions under a lot of pressure, is also bouncing slightly, at least against most of its counterparts.  We have already discussed the yen’s gains, but vs. the rest of the G10, it is firmer by roughly 0.15% or so while vs. its EMG counterparts some are seeing losses  (CE4 -0.3% to -0.4%) while there are others with modest gains (ZAR +0.3%, MXN +0.4%).  For now, the trend remains for a lower dollar, and if we see a soft PCE reading this morning, I expect that to reassert itself as thus far, today’s price action appears more like a trading response to the recent weakness.

In addition to the PCE data, we also see Personal Income (exp 0.4%), Personal Spending (0.3%), the Goods Trade Balance (-$99.4B) and Michigan Sentiment (69.3).  Mercifully, on the Fed front, only Governor Bowman speaks, she of the dissent at the last meeting, although yesterday’s plethora of Fed speakers taught us nothing new at all.  

I don’t have a strong opinion as to how this data will play out, but I would caution that if PCE is firmer than expected, look for a hiccup in the recent euphoria over stocks and bonds, while the dollar consolidates its support.  However, if we see a softer print than forecast, watch out for a much bigger rally in stocks and a much weaker dollar.

Good luck and good weekend

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Sayonara Yen

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Ueda did not
Accept the challenge and hike
Sayonara yen

 

Market excitement has ebbed after yesterday’s massive risk rally around the world, especially with limited new information released.  The one place where there was a chance for excitement was Tokyo, where the BOJ was meeting.  Heading into the meeting, the analyst community anticipated no policy changes although it seems clear that there were at least some market participants who thought Ueda-san would take this opportunity to surprise markets once more.  However, in this case, the analysts were correct.  Policy was left as is, with the overnight rate remaining at 0.25%, and there was no discussion regarding the reduction of QE at all, in fact, the most noteworthy thing about the policy statement was the frequency with which they used the term ‘moderate’ or variations thereof.  

They explained that the Japanese economy’s recovery, overseas economies’ growth, corporate profits, private consumption, business fixed investment, and inflation expectations have all been increasing moderately.  As such, the unanimous decision was that policy was just fine already with no imminent concern over rising inflation and no need to do anything.  The upshot is that the Nikkei (+1.5%) continues its recent rebound rally, JGB yields didn’t budge and the yen (-0.9%) fell sharply, proving to be the worst performing currency in the session.  See if you can figure out when the BOJ news was released based on the chart below.  This is what I meant when I said while analysts weren’t looking for any policy changes, clearly FX traders were.

Source: tradingeconomics.com

However, beyond the BOJ nonevent, there has been very little to discuss overall.  There is still a sense of euphoria around equity markets as congratulations abound for Chairman Powell and his bold action on Wednesday, at least from the Keynesian audience.  The one other thing to mention is that the barbarous relic (+1.0%) has absorbed all this information and traded to yet another new all-time high, well above $2600/oz, dragging the rest of the metals complex along for the ride.

Some days, there is just not much to discuss, so I will recap markets and let us all start the weekend early.

Following the big rally in the US yesterday, alongside Japan, Hong Kong (+1.35%) stocks rallied as did most of Asia (Korea, India, Australia, Malaysia) although there were a few laggards (Indonesia and New Zealand stick out).  As to mainland Chinese shares (+0.15%), they did edge higher, which given their performance of late is clearly a positive, but the news from China continues to disappoint.  Last night, the PBOC left their 1yr and 5yr loan rates unchanged, unwilling to take advantage of the Fed’s rate cut to help try to boost the domestic economy.  There is talk that the government there is going to ease the Hukuo restrictions, a type of internal passport that restricts what citizens there can do, to try to goose the property market, but no confirmation of that.  

But there was also news that the youth unemployment rate rose again, up to 18.8%.  You may recall that last summer, when the numbers started to really get bad, rising above 25%, they simply stopped publishing them.  Well, they rejiggered the data and brought them back at the beginning of the year, and now they are rising once again.  China still has many intractable problems and the equity market there seems likely to remain under pressure for a while yet.  As to US futures, at this hour (7:00) they are backing off a bit from recent highs, down -0.25% or so.

In the bond market, it is an extremely quiet session everywhere, with Treasury yields edging higher by 1bp and similar moves in some European sovereign markets while others remain unchanged.  It seems that with central bank meetings now behind us, there is no reason to anticipate the next move yet, so no reason to rock the boat.  I assume that as more data shows up, NFP, inflation, etc., we will see more movement, but for now, likely very little activity.

As mentioned above, the metals markets are rocketing this morning but the same is not true in energy with oil (-0.3%) and NatGas (-0.6%) both slipping a bit.  However, both have had strong weekly rallies, so this feels much more like a profit taking response as traders head into the weekend than anything fundamental.  After all, escalation in the Middle East doesn’t seem to faze traders, nor in Russia/Ukraine. 

Finally, the dollar is a touch higher overall, but really, in the G10 other than the yen, most currency movements have been very modest.  In the emerging markets, CNY (+0.25%) is the outlier, with those looking for a cut unwinding their short positions, but we have seen weakness elsewhere (KRW -0.65%, MXN -0.25%, ZAR -0.25%) all of which seem to be a reaction to the dollar’s sharp decline of the past two sessions.  Again, profit-taking on a Friday with no data is pretty common.

And that’s really it.  There is no data and only one Fed speaker, Philly Fed president Harker, who will be the first post-FOMC speaker we hear.  It is hard to get excited about anything in the markets today.  I expect that we will see more profit taking in those markets which moved significantly, like equities and eventually metals by the close.  In fact, if the metals markets don’t retrace, I think that could be a signal that there is a larger move in that space coming our way.

Good luck and good weekend

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Recalibration

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All week we had heard many clues
That fifty is what Jay would choose
And that’s what he cut
With only one but
From Bowman, who shuns interviews
 
The key is now recalibration
In order to tackle inflation
Without driving higher
The joblessness spire
So, trust us, it’s all celebration

 

“Recent indicators suggest that economic activity has continued to expand at a solid pace. Job gains have slowed, and the unemployment rate has moved up but remains low. Inflation has made further progress toward the Committee’s 2 percent objective but remains somewhat elevated.” [emphasis added]

Reading the opening paragraph of the FOMC Statement, it might be confusing as to why they needed to cut rates 50bps.  After all, the economy is expanding at a solid pace (In fact, after the Retail Sales data on Tuesday, the Atlanta Fed’s GDPNow reading for Q3 is up to 3.0%!)  unemployment remains low and inflation is still somewhat elevated.  I know I am a simple poet, but the plain meaning of those words just doesn’t lead my thinking to, damn, we better cut 50 to get started.  But I guess that is just another reason I am not a member of the FOMC.

Perhaps the more interesting thing was the Summary of Economic Projections and the dot plot which showed that while expectations were for rates to fall far more dramatically than in June, the longer run expectations continue to rise.  In fact, Chairman Powell specifically addressed the SEP in the press conference, “If you look at the SEP you’ll see that it’s a process of recalibrating our policy stance away from where we had it a year ago when inflation was high and unemployment low to a place that’s more appropriate, given where we are now and where we expect to be, and that process will take place over time.” [emphasis added] In fact, there was a lot of recalibrating going on as that appears to be the Chairman’s new favorite word, using it 8 times in the press conference.

Source: federalreserve.cgov

Notice that their current forecasts are for GDP to slow to 2.0% with Unemployment edging only slightly higher while PCE inflation magically returns to their 2.0% target.  And take a look at the last two lines, with the Fed funds rate projections falling substantially for the next three years, far more quickly than their previous views, although they think the long-run level will be higher.  

I wonder about that last issue.  Historically, the thought was that the long run Fed funds rate would be inflation (2.0%) + real interest rate (0.5%) and they pegged it at 2.5% for years.  Now that they see it at 2.9%, is that because they think inflation is going to be higher (not according to their projections) which means that for some reason they think real interest rates are going to be higher.  However, when asked, Chairman Powell and every member of the board has been unable to explain this change.

But what really matters is how have markets responded to this earth-shattering news?  The initial movement was as expected, with stocks rallying sharply (see chart below) and yields sliding along with the dollar while commodities rallied.

Source: Bloomberg.com

But a funny thing happened on the way to the close, as can be seen in the chart.  Stocks gave back all their gains and then some, with all three major indices lower on the session while 10yr Treasury yields backed up 7bps and the dollar rebounded.  Arguably, this was a sell the news response, but we need to be careful.  Remember, there are many analysts who believe the economy is in deep trouble already and by starting off with a big cut, those with paranoia may be wondering what the Fed knows that the data, at least the headline data, is not really showing.

So much for yesterday, now let’s look at markets this morning beyond the initial knee-jerk responses.  Absent any other major news or data (Norgesbank leaving rates on hold doesn’t count as major), markets have played out far more along the lines of what would have been expected in the wake of a 50bp cut.  In other words, the dollar has fallen sharply against almost all its counterparts, equity markets have rallied around the world, commodity prices have rallied sharply, and bond yields are…unchanged? 

Which brings us to the question that has yet to be answered.  Which market is right, stocks or bonds?  They appear to be telling us different stories with stocks pushing to new highs amid rising multiples and rising profit growth expectations while bonds are pricing in another 200bps of rate cuts by the end of 2025, an outcome that would only seem to make sense in the event the economy fell into a recession.  But if we are in a recession, corporate earnings seem highly unlikely to rise as much as currently forecast and typically, P/E multiples contract.  Meanwhile, if the economy is humming along such that current equity pricing is warranted, what will be the driver for the Fed to cut rates as that will almost certainly reignite inflation.  

History has shown that the bond market tends to get these big questions right when they are pointing in different directions, but that doesn’t mean that risk assets will stop rallying right away.  In fact, this will likely take quite a while to play out.

Ok, so let’s put a little more detail on the market activity overnight.  Tokyo rocked (+2.0%) as did Hong Kong (+2.0%), Taiwan (+1.7%), Singapore (+1.1%) and even mainland China (+0.8%) managed to rally some.  It appears that investors around the world believe the Fed has opened the floodgates for a much lower interest rate environment everywhere.  European bourses, too, are sharply higher led by the CAC (+2.1%) but with strength across the board (DAX +1.5%, FTSE 100 +1.3%).  And US futures have shaken off the late selloff yesterday and are firmly higher this morning led by the NASDAQ (+2.2%).

Bond yields, though, are largely unchanged on the day, with yesterday’s backup in Treasury yields maintained and European sovereigns all within 1bp of yesterday’s close.  It appears that bond investors are less confident in a soft landing than equity investors.  Interestingly, JGB yields rose 2bps last night as Japanese markets prepare for the BOJ meeting tonight.

In the commodity markets, oil (0.75%) is continuing its recent rebound after another massive inventory draw was revealed by the EIA yesterday prior to the Fed meeting.  There is a growing concern that inventories in Cushing, Oklahoma are falling to a point where products like gasoline and diesel will not be able to be produced.  As an example, gasoline futures have risen far more than crude futures this week on that fear.  As to the metals markets, gold briefly touched $2600/oz yesterday immediately in the wake of the FOMC but sold off hard afterwards.  This morning, however, it is back pushing up to that level again and the entire metals complex is rising nicely.

Finally, the dollar, has been a whipsaw of late.  Post the FOMC, it fell sharply across the board, and then into yesterday’s close it rebounded to close higher on the day.  However, this morning it has given back all those late gains and then some, and is now sitting at its lowest level, at least per the DXY, since April 2022.  This morning, in the G10, we are seeing many currencies rally between 0.5% (EUR) and 1.3% (NOK) vs the dollar and everywhere in between.  The one exception to that is the yen (-0.2%) which is biding its time ahead of the BOJ meeting.  The working assumption is that the BOJ will do nothing tonight, but now that the Fed has cut 50bps, and given Ueda-san’s history of actively trying to surprise markets to achieve outcomes he wants, we cannot rule out another rate hike in Japan.  Monday morning, USDJPY fell below 140 for the first time in 18 months.  My take is Ueda-san is quite comfortable with it heading back to the 130 level, if not the 120 level.  If he were to surprise markets and raise the base rate by even 10bps tonight, I think we would see a sea change in sentiment and a much lower dollar.  And given inflation in Japan seems to have stalled at 2.8%, well above their 2.0% target, he has a built-in excuse.

Too, watch the CNY (+0.45%) as it is now trading at its highest level (weakest dollar) in more than a year, and is approaching the big, round number of 7.00.  the linkage between JPY and CNY is tight as they constantly compete in markets, especially now in autos and electronics.  If the Fed is really going to cut as much as markets are pricing, both these currencies should strengthen much further.

It is almost anticlimactic to discuss the data today but here goes.  First, the BOE left rates on hold, as expected and the market impact was limited.  Expectations are they will cut next in November.  As to data, we see Initial (exp 230K) and Continuing (1850K) Claims, Philly Fed (-1.0) and Existing Home Sales (3.90M).  None of that is likely to change any views.  Prior to the BOJ meeting, at 7:30 this evening we see Japanese CPI, which may change views there.

For now, the dollar is very likely to remain on its back foot as enthusiasm builds for multiple rate cuts by the Fed going forward.  However, if the data continues to impress like it has lately, that enthusiasm will need to be tempered.

Good luck

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Fednesday

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Well, Fednesday is finally here
And traders, for fifty, still cheer
But arguably
The prices we see
Account for a half-point rate shear
 
So, if they just cut twenty-five
Prepare for a market nosedive
The doves will all scream
Jay’s killing the dream
While hawks everywhere all will thrive

 

First, I did not create the term Fednesday, I saw it on Twitter but thought it quite appropriate.  In fact, looking, I cannot determine who did create it but kudos to them.

As I have already written twice on the subject of today’s meeting, I will be brief this morning, especially because not much has changed.  Yesterday’s stronger than expected Retail Sales data resulted in Fed funds futures reducing the probability of a 50bp hike during the session, but overnight, we have returned to the 65%/35% probability spectrum for a 50bp cut.  I continue to believe that will be the case based on the number of articles we have seen in the mainstream media about the merits of a 50bp cut, mostly centering on the idea that rates are “too” high despite the fact that growth continues apace, the employment situation remains solid, if cooling somewhat, and inflation remains well above target.  Perhaps the big surprise will be that there will be a dissent on the vote, something we have not seen in two years.  (In fact, the last time a governor dissented was 2006 I believe).  

But something I have not touched on is the dot plot which will give us an idea as to the members’ collective belief for the rest of the year.  For instance, if the dot plot indicates Fed funds will be at 4.5% by year end, then 25bps today will be followed by at least one 50bp cut.  That should be net equity bullish and bearish for the dollar.  If the dot plot indicates only 75bps of cuts, so 4.75% at year end, my take is that will be seen as somewhat hawkish overall, and we should see risk assets decline while the dollar rallies.  Finally, if it is more than 100bps expected, I think that could be a situation of the market asking, what does the Fed know that we don’t?  That would not be a positive for risk assets but would also hammer the dollar.  Bonds would rally as would gold.  At least those are my views.

Moving on, tomorrow brings a BOE meeting where the current expectation is for no cut, although one is priced for the next meeting in the beginning of November.  Early this morning, the UK released its inflation report which showed headline CPI at 2.2%, as expected while the core rate rose to 3.6%, a tick more than expectations and up 0.3% from the July reading.  Arguably, that is what has the BOE concerned, the fact that despite the decline in energy prices which has taken headline CPI lower, the underlying stickiness of inflation remains extant within the UK.  As well, the UK also released its PPI data, all of which showed declines greater than expected, if nothing else implying that UK corporate margins should be healthy.  The pound (+0.35%) has rallied on the news, although the dollar is weaker overall, so just how much of this move is UK related is open to debate.  I guess we can say that the short-term differences in central bank stance is likely to continue to help the pound for a while.  In fact, the pound is back to levels last seen in summer 2022 and there is a growing bullish sentiment for the currency based on current perceptions of the divergence between the Fed and BOE.  My view is the BOE will fall in line pretty quickly so this will change, but for now, especially with the dollar under broad pressure, the pound has further to go.

On Friday we’ll learn
If Ueda can once more
Surprise one and all

The other central bank meeting this week is the BOJ early Friday morning.  Currently, there is no expectation of a BOJ policy change although many analysts are looking for a rate hike by December.  However, I think it is worth looking at USDJPY in relation to the policy adjustments we have seen by both central banks over the past several years.  Hopefully you can see in the chart below that the exchange rate here has returned to the level when the Fed last raised rates in July 2023.  

Source: tradineconomics.com

Since then, after a dramatic further decline in the yen, with both policy rates on hold, the BOJ first adjusted the cap on YCC higher (from 0.50% to 1.0%) then eventually raised the policy rate from -0.1% to +0.25% where it is today.  During that time, Ueda-san has surprised markets several times, and has had help from the MOF regarding intervention, taking a completely different approach to the process than the Fed, who never wants to surprise markets. With this in mind, we must be prepared for another surprise on Friday.  One thing to remember is that the BOJ meeting announcement occurs after the market in Tokyo closes, so even though other markets, and of course the FX market will be able to respond, the Tokyo equity and JGB markets won’t be able to move until Monday.  The point is the reaction may take time to play out.  In this situation, I don’t have enough information to take a view, but I will say that if he tightens policy in any manner, USDJPY is likely to fall much further.

One other thing I realize is that I have not discussed QT/QE.  If the Fed changes that process, the current $25 billion/month of balance sheet runoff, that will be extremely dovish and be quite a boost for stocks, bonds and commodities while the dollar will get run over.

Ok, heading into this morning, and after a mixed and lackluster session yesterday in the US, Asian equity market all rallied with Japan (+0.5%) continuing its recent rally, while even mainland Chinese shares (CSI 300 +0.4%) managed a gain today.  However, European bourses are all softer this morning with the FTSE 100 (-0.6%) lagging after the higher-than-expected inflation data driving concerns the BOE won’t cut rates much.  But screens everywhere are red, albeit only modestly so.  US futures are currently (7:45) edging slightly higher as I continue to believe traders and investors are looking for a 50bp cut.

In the bond market, yields are higher across the board as the euphoria we have seen lately seems to be running into a bit of profit taking with Treasury yields higher by 3bps and European sovereign yields all higher by between 4bps and 6bps.  Perhaps the one surprise is that JGB yields are unchanged this morning as there seems to be no anticipation of a BOJ move, at least not yet.

In the commodity markets, oil (-1.0%) is giving back some of its recent gains but remains above $70/bbl.  It seems that the stories of a massive military strike by Ukraine deep in Russia have raised concerns amongst the punditry of an escalation of the war there, but it has not concerned energy markets, at least not yet.  In the metals markets, gold (+0.2%), which sold off yesterday, continues to find support while copper has been on a roll and has risen once again.  

Finally, as mentioned above, the dollar is softer overall against all its G10 counterparts and most EMG currencies as well. The one outlier here was KRW (-0.35%) where traders are starting to price in rate cuts by the BOK after yet another mild inflation report earlier this week.

Ahead of the Fed we see Housing Starts (exp 1.31M) and Building Permits (1.41M) as well as the EIA oil inventory data where expectations are for no real changes.  Until the FOMC release, look for quiet markets. Afterwards, I’ve given my views above.

Good luck

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That Trade Again

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Remember when everyone knew
That BOJ hikes would come through
The Fed would cut rates
And all the debates
Were focused on what next to do?
 
It turns out the very next thing
For those getting back in the swing
Was selling the yen
(Yes, that trade again)
And buying stuff that has more zing

 

We all know that the carry trade died two weeks ago.  After all, the BOJ hiked rates in a surprise to the markets which was followed by Chairman Powell essentially promising to cut rates.  Those actions spooked traders, and arguably algorithms as well, and we saw a dramatic decline in equity markets around the world, led by Japanese stocks.  The premise was that much of the market activity was driven by borrowing yen at near 0.0% and then converting those yen into other currencies and buying other assets, or just depositing the dollars, or Mexican pesos or Brazilian reals and earning the interest rate differential.

Now, don’t get me wrong, that was an active trade and clearly a part of the ongoing risk asset rally that was evident throughout most of the world.  But that trade took several years to build up, and the idea that it was unwound in a week is laughable.  But, that sharp move two weeks ago succeeded in doing one thing, it scared the 💩 out of the central bankers around the world.  Within days, the BOJ walked back all their tough talk about normalizing monetary policy and ending QQE.  As well, despite desperate calls from some of the punditry for an emergency rate cut, or at the very least, a guarantee of a 50bp cut in September by the Fed, the few Fed speakers we have heard continue with their mantra that while some things are looking encouraging, the time is not yet right to cut rates.

And, you know what that means?  It means that the interest rate differentials between Japan and the rest of the world remain plenty wide enough to reinvigorate that self-same carry trade that was declared dead just two weeks ago.  The obvious proof is in the equity markets which, while not quite back to the highs of July 16th, have rebounded between 6.8% (S&P500) and 8.8% (NASDAQ) from the bottoms seen at the beginning of the month.  (see chart below)

A graph of a line graph Description automatically generated with medium confidence

Source: tradingeconomics.com

But equally important to this story is the fact that the yen has declined more than 4% from its highs at the peak of the fear as investors are far less concerned about much tighter BOJ policy.  This is also evident in the JGB market, where 10-year yields, while climbing 3bps overnight, remain well below the 1.0% level that was seen as a harbinger of the new monetary framework in Japan.

A graph showing the price of a stock market Description automatically generated

Source: tradingeconomics.com

Of course, there has been other news that has abetted this price action, namely the recent US data which showed that the employment situation may not be as dire as the NFP report at the beginning of the month.  This was demonstrated yet again yesterday when Initial Claims fell to 227K, its lowest point in 5 weeks and the second consecutive decline in the result.  As well, Retail Sales were a much stronger than expected 1.0% (although the autos component seemed a bit funky), indicating that real economic activity was still growing.  Granted, the IP (-0.6%) and Capacity Utilization (77.8%) data were soft as were both the Philly Fed (-7.0) and Empire State Manufacturing (-4.7) surveys, but none of that matters when the markets get on a roll.

If I had to describe the narrative this morning it would be, everything’s fine.  The economy is still doing well, the jobs market is not collapsing, and the Fed is still on track to cut rates next month.  Goldilocks has come out of hiding and is back headlining the show.  While there are still some doubters out there, their voices are being drowned out by all the shouting to buy more stocks.

So, as we head into the weekend, let’s see how things have performed overnight.  In Asia, markets everywhere rallied following the strength in the US yesterday.  The Nikkei (+3.6%) led the way and has now rebounded more than 20% from its nadir at the height of the fear.  But the Hang Seng (+1.9%) showed strength and we saw strength throughout the region (Australia +1.3%, Korea +2.0%, India +1.7%) with one notable exception, mainland China, where shares edged up just 0.1%.  It seems that President Xi has, at the very least, a marketing problem with respect to getting investors to put money into China. In Europe, most markets are higher between 0.25% (CAC) and 0.6% (DAX) although the FTSE 100 (-0.4%) is struggling this morning after Retail Sales data there were seen as less than stellar.  As to the US, ahead of the opening futures markets are little changed at this hour (7:15).

In the bond market, yesterday’s stock euphoria played out as a sale of bonds with the corresponding rise in yields of 7bps in the US Treasuries.  However, this morning, those yields have backed off by 5bps and we have seen similar price action throughout Europe with sovereigns there showing yield declines of between 3bps and 5bps after following Treasury yields higher yesterday.  For now, bonds are certainly behaving like a haven asset.  Also, it is worth noting that the yield curve inversion is back to -17bps, edging slowing away from normalization.

In the commodity markets, after a solid performance yesterday, oil (-2.6%) is under real pressure this morning as market participants look to the lackluster Chinese economic activity and are worried that demand is not going to pick up anytime soon.  Certainly, yesterday’s Chinese data was nothing to write home about, and this morning they released their Foreign Direct Investment data showing it had decline -29.6% YTD in July.  This does not inspire confidence.  In fact, under the rubric a picture is worth 1000 words, here is a chart of that Chinese FDI.  It seems clear that something has changed in the way the world views China.

A graph of blue and orange lines Description automatically generated

Source: tradingeconomics.com

As to the metals markets, gold (+0.4%) continues to find support as despite the equity rally, there remains a steady interest to hold something other than USD and fiat currencies.  However, the rest of the complex is softer this morning as weaker industrial activity would indicate less demand.

Finally, the dollar is ceding some of its gains from yesterday with some pretty substantial moves in both G10 and EMG blocs.   Versus the G10, the yen, which fell sharply yesterday, has rebounded 0.75% this morning, although remains above 148.  But we have seen strength in AUD (+0.3%), NZD (+0.7%) and GBP (+0.35%) as virtually all the G10 is firmer.  The pound is a bit odd given the equity market’s response to the UK data, but the other currencies seem to be simply retracing yesterday’s weakness.  In the EMG bloc, ZAR (+0.4%) is firmer on the back of gold and the generally weak dollar, but we are seeing MXN (-0.2%) lag the move.  CNY (+0.2%) is also benefitting today as broad dollar weakness plays out far more aggressively here than it has historically.  While the dollar’s long-awaited demise is still far in the future, today it is under some pressure.

On the data front, this morning brings Housing Starts (exp 1.33M), Building Permits (1.43M) and Michigan Consumer Sentiment (66.9).  As well, this afternoon we hear from Chicago Fed president Goolsbee.  He has been one of the more dovish FOMC members so look for him to talk up the chances of a more aggressive rate cut next month.  However, there is still a lot to learn between now and then with PCE next week, then another NFP and CPI report as well as the Jackson Hole conference.  As it stands this morning, the Fed funds futures market is pricing a 27% chance of a 50bp cut, with 25bps a lock.  But if the data continues to shine, please explain why they need to cut.  I think we are in a ‘good news is good’ scenario, so strength in this morning’s data should support the dollar and weakness impair it.  We shall see.

Good luck and good weekend

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Never Mind

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The markets just said, never mind
Though yesterday’s moves were unkind
Twas all just a game
With punters to blame
It’s they who must need be maligned
 
Today is a whole other story
And one that is somewhat less gory
Now though it seems strange
Things just didn’t change
Believe us, it’s all hunky-dory

 

As much fear as was felt throughout global markets yesterday, that is how much relief is evident this morning.  In the midst of a panic sell-off, it is impossible to determine both the causes and how far things might run.  In fact, that is why stock exchanges around the world introduced circuit-breakers after the 1987 crash, to try to prevent any extended move lower.  As it happens, the only circuit breakers that triggered were in Asia (Japan, South Korea and Taiwan) as the rest of the world’s markets, though sharply lower, did not see the same magnitude of losses.

But that was so yesterday!  To their credit, no central bank reacted rashly to the movement, and there were precious few comments by any central bankers of note.  SF Fed President Daly spoke at a scheduled event and maintained the party line that they did not yet have enough confidence that inflation was going to sustainably decline to their target, although she is closely watching the labor market after last Friday’s NFP report.  “We’ve now confirmed that the labor market is slowing, and it’s extremely important that we not let it slow so much that it tips into a downturn.  It’s too early to tell if it is slowing to a sustainable pace which allows the economy to continue to grow or if it’s getting to a point where there’s real weakness there,” she explained.

Those comments certainly did not sound like someone who was concerned about the market’s dramatic movement yesterday.  And we should all be happy that is the case.  In fact, the central bank that should have been most concerned, the BOJ, said nothing at all.  As well, the RBA met last night and left policy on hold, as expected.  So, kudos to the central bank community for not overreacting to a stock market move.

Market participants, though, continue to clamor for support as they are confused by numbers that don’t go up.  Now, Tuesday has earned the name ‘turnaround Tuesday’ for a good reason, in that historically, after a large decline on Monday, especially if there was weakness at the end of the prior week, on average, there is a rebound in equity markets.  In fact, there was a very nice article in Bloomberg this morning giving details on that phenomenon.  

But the real question is, was yesterday an aberration or was it a harbinger of things to come?  On the one hand, the only data released yesterday was the ISM Services, which rose 2.6 points to 51.4, a much better than expected outcome, and certainly not seeming to be a signal that the US economy is heading into recession.  Ironically, if there is no recession coming, and the Fed remains sanguine about the economy, there is really no reason for them to worry about the interest rate structure.  I have asked this question many times, why would the Fed need to cut rates if the economy continues to grow at trend and equity markets continue to make new highs? 

But we cannot ignore the signals we have seen from other parts of the economy, notably the still weak manufacturing sector (as evidenced by the weak ISM Manufacturing and other regional Fed manufacturing indices) and the evident slowing in the payroll report.  Many of you will have heard of the Sahm Rule, which describes the relationship between movement in the Unemployment Rate and recessions.  

Briefly, the rule explains that if the three-month average of the Unemployment Rate rises 0.5% from its low point in the past 12 months, that signals the economy is already in a recession.  Last Friday’s rise in the UR ostensibly triggered that “rule”.  However, it is important to understand that the rule is merely the observation that since 1980, that situation has obtained each time a recession has occurred.  It is not a causal factor, just a coincidental indicator, so the fact that it has been triggered does not actually mean we are in a recession, just that historically that has been the case.

I have described numerous times that there are two broad camps of economists with some very smart people continuing to believe that we are already in a recession, even prior to Friday’s NFP report, and that the Fed is far behind the curve.  However, there is also a camp that believes in the no-landing scenario where the economy will be able to maintain its pace of growth given the combination of massive fiscal stimulus that continues to enter the economy, and the fact that the interest rate sensitivity of the US economy has declined dramatically since 2020 because so many borrowers, both individuals with mortgages and companies, termed out their debt during the ZIRP policy period.

However, there are several things to remember:

  • The stock market is not the economy.  Markets are forward looking indicators of indeterminate length, and while they may presage strength or weakness, they also get things wrong.  So, this market movement could merely be a trading correction amid ongoing economic growth, or it could be the beginning of the end.
  • The US economy’s reduced sensitivity to interest rates means that even if the Fed were to cut rates tomorrow, the impact on the economy is likely to take at least 12 months, if not much more before it is felt.  After all, the Fed started hiking rates two years ago and in Q2, GDP was still growing at 2.8% with inflation continuing above their target.
  • Interest rate markets often, if not almost always, are incorrect in their pricing of future Fed policy moves.  The below chart from Deutsche Bank Research shows the actual Fed funds rate (red line) and the way the futures market was pricing things at various points in time (black dashed lines).  As you can see, there are a lot more bad outcomes than correct ones.

I know I regularly discuss the Fed funds futures market, but I do so as an indicator of market sentiment, not an expectation of what the Fed will actually do.  And FWIW, this morning the futures market is pricing a 75% chance of a 50bp cut in September, up from Friday’s level of 25%, but down from the peak of 95% yesterday morning.

Ok, let’s tour markets very quickly now.  The Nikkei rebounded by 10.2% last night, its largest rise ever in a single session.  The other big decliners yesterday, South Korea (+3.3%) and Taiwan (+3.4%) also rebounded, although not nearly as impressively.  Chinese shares have basically sat this movement out, little changed last night after modest declines on Monday.  In Europe, the picture is mixed with the DAX (+0.1%) managing a gain while the CAC (-0.25%) and IBEX (-0.4%) both still lag.  The only data of note was Eurozone Retail Sales which disappointed at -0.3%.  US futures are rebounding as well, up about 1.0% at this hour (7:30).

In the bond market, Treasury yields bottomed yesterday morning at about 8:30 printing at 3.68% but have risen since then by a total of 20bps, with 7 of those occurring this morning.  Meanwhile, European sovereign yields are generally a touch softer, down between 1bp and 3bps as the European markets have ultimately seen limited impact from the big moves.  I guess, nobody was buying European stocks or bonds with their short yen funded positions.  As to JGB’s they also rebounded last night, closing higher by 11bps, although still well below the 1.0% level.

In the commodity markets, oil (-0.2%) spent most of yesterday rebounding alongside Treasury yields, and likely showing a little concern over the imminent (?) retaliation by Iran on Israel.  However, in the big scheme of things, it remains in its 70/90 range and obviously needs a bigger catalyst than we saw yesterday to break it.  Gold (+0.4%), which sold off yesterday, was the least impacted of risk assets and it is no surprise it is rebounding this morning.  The rest of the metals markets, though, remain under modest pressure after sharp declines yesterday.

Finally, the dollar has reversed some of yesterday’s moves, but there continues to be a wide range of movement.  Starting with the yen, during the NY session yesterday, the dollar rebounded sharply, more than 1.5% and though that move continued into the early Asian hours, right now, the yen is stronger (dollar lower) by 0.5%.  Elsewhere, though, the dollar is showing its haven status as it rallies vs. the rest of the G10, in some cases pretty substantially (GBP -0.75%, AUD -0.6%) and it is rallying against virtually all of the EMG bloc with the worst performers the MXN (-1.1%) and CE4 currencies, mostly lower by about -0.5%.

On the data front, today’s only release is the Trade Balance (exp -$72.5B) and I do not see any Fed speakers listed on the calendar.  Perhaps yesterday was a one-off, a type of warning shot across the bow of the economy that things are out of balance and subject to some jarring impacts.  Or perhaps it was just one of those things that markets periodically do irrespective of the economic fundamentals.  This poet remains in the camp that economic activity is slowing, and a recession is coming soon, although that will not necessarily help inflation decline.  But right now, it is anybody’s guess.  As to the dollar, nothing has changed its haven status I believe, so if fear continues to drive things, it should hold its own.

Good luck

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The World is Ending

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The world is ending
At least, that’s the way it feels
Owning equities
 
The narrative writers are caught
‘Cause stories those writers had wrought
No longer apply
And folks now decry
The idea that dips should be bought
 


Remember the idea of the summer doldrums where everybody is on vacation, so markets move very little? Yeah, neither do I!  Here’s a different idea though, when risk is under pressure, all correlations go to 1.0.  Look at the following three charts (source: tradingeconomics.com) and explain to me how they behave independently:

There is rioting in the streets today, perhaps not in your neighborhood directly, but in many places around the world (the UK, Bangladesh, Kenya, others), as the global order that we have known for the past X years gets tested.  How big is X?  There will be many different answers to that question, but in this poet’s mind, what we are witnessing in its full glory today is the beginning of the unwinding of the market excesses that began when global interest rates headed to 0.00% in the wake of the GFC in 2009, so X=15 years.  

It is easy to wax philosophical on this subject, discussing the merits of moderating the business cycle and why interest rate policy is a net benefit, and you can be sure that before this week is over, we will get policy interventions.  But ultimately, markets need to clear to function effectively, and I would argue that the last time markets actually cleared was in 1974.  The next big opportunity to allow markets to clear was in October 1987 and the Maestro, although he had not yet earned that moniker, stepped in after that Black Monday and promised unlimited liquidity to prevent too much damage. 

Ever since then, central bankers around the world, led by the Federal Reserve, but do not forget actions like Mario Draghi’s “whatever it takes” moment, have decided that they need to manage the global economy, and market responses, and that markets were only effective if they were going higher.  (It’s ironic that TradFi people scoffed at the crypto maxim ‘number go up’, yet they believed exactly the same thing, only in a different wrapper.) As well, we all know that the concept of political will does not exist anymore, at least not in the West, as no elected politician will ever choose to fight for a policy that has short-term pain and long-term gain.  The result of this constant intervention and guidance from policymakers is that things get overdone, and bubbles inflate.  And it is much easier to inflate a bubble when you maintain policy rates at 0.00% (or negative rates in some cases).  

At this point, you will read many stories about which particular catalyst drove this market reaction, whether it was last week’s BOJ meeting where Ueda-san surprised the market and hiked rates as well as promised to reduce QQE, or whether it was the fact that Chairman Powell did not cut rates, or if it was the weak payroll report.  Others will point to the escalation in hostilities in Ukraine and the Middle East as flashpoints getting people to exit risk positions.  But in the end, the catalyst is not important.  As I wrote on Friday, and is so well explained in Mark Buchanan’s book, Ubiquity, the market was rife with ‘fingers of instability’ and an avalanche has begun.

To this poet’s eye, there needs to be more excess wrung from the market.  After all, given the underlying trade of virtually the entire bull market has been the JPY carry trade, where traders and investors borrowed JPY at 0.00%, converted it to another currency and either held that currency to earn the interest rate differential, or for the truly aggressive, used the currency to buy other risky assets (NVDA anyone?), and that trade has been building for years.  Deutsche Bank has estimated that it grew to $20 trillion in size.  I assure you it is not completely unwound!

However, as I mentioned above, I am confident that central bankers are already getting intense pressure from their respective governments to ‘do something’ to stop the rout.  But central bankers are already (save Japan) in cutting mode.  And the Fed just passed on cutting rates last week.  If they were to cut today, no matter what they said, it would remove any doubt that the only thing they care about is the stock market.  It would destroy whatever credibility they still retain.  But do not count out that response, at this stage, it’s probably 50:50 they cut this week if things continue.  After all, the Fed funds futures market is now pricing in a 95% probability of a 50bp cut in September and a total of 125bps of cuts by December!

I will be the first to say I have no idea where things are going to head from here because while market internals point to further unwinding of risky assets, policy responses have not yet been seen.  So, the best advice I can offer if you are not leveraged is do not panic.  If you are, you have probably been stopped out already anyway.  In the meantime, let’s take a look at the damage overnight.

Equity Markets in Asia:

  • Nikkei 225       -12.4%
  • Hang Seng       -1.5%
  • CSI 300            -1.2%
  • ASX 300           -3.7%   
  • KOSPI               -8.8%
  • TAIEX               -8.3%
  • Nifty 50           -2.7%

In other words, it was quite the rout, with tech shares getting hammered everywhere.  Perhaps the most surprising thing to me as that the CSI 300 didn’t fall further, although I suspect that there was significant intervention by the government to prevent that from happening.  (After all, you don’t need to be a western government to want the number to go up!)

Equity Markets in Europe:

  • DAX                 -2.6%   
  • CAC                 -2.4%
  • FTSE 100         -2.4%
  • IBEX                 -2.8%’
  • FTSE MIB         -3.0%

This tells me that these markets were not nearly as leveraged as Asian markets, likely because prospects throughout Europe have been relatively less interesting to many investors.  After all, if you are leveraging up via borrowing yen, you want to buy growth, not value, stocks, and there aren’t that many growth names in Europe.

Finally, US futures, at this hour (7:00) are lower by:

  • S&P 500          -3.0%
  • NASDQ            -4.5%
  • DJIA                 -2.1%

Bond markets are also seeing very significant movement, in the opposite direction as they are performing their safe haven role brilliantly today.  While the movements today are solid, with Treasury and European sovereign yields all lower by between 5bps and 7bps, to see the real story, you need to see the move since Friday’s opening (these are all 10-year yields).

  • US                    -20bps
  • Germany         -10bps
  • UK                   -9bps
  • Japan               -20bps
  • Australia          -17bps

The US yield curve, at least the 2yr-10yr measurement, is virtually flat today and 30yr yields are now higher than both of those maturities.  Also, look at JGB yields, down to 0.77%, as Japanese investors take their toys and go home.  The thing about this move, and the reason I don’t believe the unwinding is over yet, is that once the Japanese investment community starts to move, it takes a long time for them to get to be where they want given the amount of the assets involved.  And despite all the clutching of pearls about the US ability to sell the amount of debt they need to fund themselves; it won’t be a problem for right now.  Many people around the world will be all too happy to buy Treasury bonds regardless of some political foibles in the US.

Commodity markets are under pressure this morning, but not seeing the same type of pain as equity markets. The story here is that commodities are not directly impacted by the current movements (if anything declining interest rates should help them) but when margin calls come, people sell whatever they can that is liquid.  So, gold (-1.6%) is being liquidated to cover margin calls, not because people don’t want it.  Oil (-1.6%) is likely feeling pressure because these equity moves presage potential economic weakness and a reduction in demand, and we are seeing the same response from the industrial metals.  My take is gold is the one thing, besides bonds, that people are going to be willing to hold, and will rebound first.

Finally, the dollar is under pressure, net, but we are seeing massive movements in both directions.

  • JPY       +2.5%
  • EUR     +0.4%
  • GBP     -0.3%   
  • AUD     -0.9%
  • MXN    -3.3%
  • NOK     -1.0%
  • ZAR      -2.0%
  • CNY     +0.8%  
  • CHF      +0.8%
  • KRW    -0.5%

See if you can determine which were the favorite currencies to hold long against short JPY (AUD, MXN, ZAR). Meanwhile, the renminbi is able to gain as it continues to weaken, net against the yen, its most important competitor.  Remember, currencies are the outlet valves for economies when other markets cannot move enough.  The thing to keep in mind, especially as a hedger, is that volatility is going to be very high for a while yet.  This will not all quiet down and go away in a week’s time. 

At this point, it’s fair to ask, does data matter anymore?  Probably not today, but it will be key for the central banks if for no other reason than to cloak their actions in some fundamental story.  Alas for the Fed, there is virtually nothing to be released this week.  All we see is:

TodayISM Services51.0
TuesdayTrade Balance-$72.4B
ThursdayInitial Claims250K
 Continuing Claims1880K

Source: tradingeconomics.com

As well, and perhaps remarkably, so far on the calendar we only have three Fed speakers, Goolsbee, Daly and Barkin.  However, it seems almost certain we will hear from others, especially if the rout continues.

Right now, fundamentals do not matter.  My sense is we will see a bounce of some sort after the first wave ends, perhaps as soon as tomorrow, but the narrative of the soft landing has been discarded.  Look for more political pressure on the Fed to act, and to act soon.  Also, do not be surprised if the rest of the week ultimately sees a slower, but steady, decline in risk assets as those who haven’t panicked react to the situation and reevaluate just how much they love their positions.  Consider, Warren Buffet sold some of his favorite positions last week and is loaded with cash to act.  But there is nobody who is more patient than he.  

Good luck

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