Tag Archives: #JPY

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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New Shibboleth

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A second rate hike
By Japan has resulted
In strong like bull yen

 

Last night, Governor Kazuo Ueda and the BOJ raised their overnight call rate to 0.25% from the previous level of between 0.00% and 0.10%.  This move was forecast by several analysts but was certainly not the base case for most, nor what this poet expected.  However, it appears that the gradual slowing in inflation in Japan was not seen as sufficient and so they moved.  By far, the biggest reaction came in the FX markets where the yen jumped sharply, now higher by 1.5% compared to yesterday’s NY close.  A look at the longer-term chart of USDJPY below shows that at its current level just above 150.00 (obviously a big round number), the currency has reached a double support level based on its 50-week moving average (the curved line) and the trend line that starts from the time the Fed began raising interest rates in March 2022.

Source: tradingeconomics.com

Surprisingly, given the sharp move seen overnight, there has been virtually no discussion as to whether the MOF asked the BOJ to intervene and further push the yen higher (dollar lower) in concert with its recent strategy of pushing a market that is moving in its favor rather than fighting a market that is moving against its goals.  Regardless, the 150 level is going to be a very important technical support, and any break below may open up another 10 yen decline in the dollar.

What, you may ask, would lead to such a move?  How about the Fed?

The pundits are holding their breath
With “cut Jay” their new shibboleth
But will Chairman Powell
Now throw in the towel
On prices and channel Macbeth?

Of course, this afternoon, the big news is the FOMC meeting wraps up and at 2:00 they release their statement which is followed by the Chairman’s press conference at 2:30.  As of this morning, the probability of a cut today is down to 3.1% according to the CME’s futures market.  However, that market has a 25bp cut locked in for September with a further 10% probability of a 50bp cut then and is pricing in a total of 66bps of cuts by the December meeting, so, a bit more than a 60% probability of three 25bp cuts by the end of the year.  That pricing continues to feel aggressive to this poet as the data has not yet shown that the economy is clearly in trouble.  Remember, too, the Fed is always reactive, despite any of their comments on trying to get ahead of the curve.

Continuing our observations of mixed data, yesterday saw that home prices, as per the Case-Shiller Index, remain robust, rising 6.8% in May (this data is always lagging), but there is little indication that the shelter component of the inflation statistics is set to decline sharply.  As well, the JOLTs Job Openings data printed at a higher than expected 8.184M, indicating that there is still labor demand out there.  Finally, the Consumer Confidence number rose a touch more than expected to 100.3.  My point is there continues to be strength in many parts of the economy and prices are nowhere near declining.  Granted, this Friday’s NFP report will take on added importance as if the numbers there start to decline and Unemployment continues its recent trend higher, there will be far more urgency to cut rates.  Perhaps this morning’s ADP Employment report (exp 150K) will help clear up some things, but I’m not confident that is the case.

Interestingly, there are still a number of analysts who are clamoring for the Fed to cut today, claiming they can get ahead of the curve and stick the soft landing.  However, history has shown that the Fed lives its life behind the curve, and there is no indication that is about to change.

There is one other thing to consider, though, and that is the politics of the situation.  While the Fed is adamant they are apolitical and only trying to achieve their mandated goals, we all know that in order to even be considered to reach the FOMC as a named member of the committee, one needs to be highly political.  Does that mean that partisan politics enters the arena?  These days, it is almost impossible for that not to be the case.  

The current narrative on this subject is that a rate cut will help the current administration, and by extension the candidacy of VP Harris.  I’m not sure I understand that given inflation, which remains a major topic of conversation around the country, especially at the proverbial kitchen table, is so widely hated across the board.  The most interesting poll results I saw were that a majority of those questioned indicated they hated inflation far more than a recession.  This surprised the economic PhD set, but as inflation is an insidious cancer on everyone’s wellbeing, it is no surprise to this poet.  My point is that a rate cut now will do exactly zero to help support growth before the election, but it will almost certainly boost the price of commodities, notably energy and gasoline, and that will show up in inflation post haste.  Thus, does the narrative even make sense?  If Powell is truly partisan (and I don’t think that is the case), he would refrain from cutting rates until September as any impact, other than in financial markets, will not be felt until long after the election.  FWIW, I agree with the market there will be no cut today, but absent a major decline in the employment situation by September, I see only 25bps there.

Ok, a bit too long to start today, but obviously there is much of importance to understand.  So, let’s look at how markets have responded to the BOJ while they await the FOMC.  As earnings season continues, the tech sector in the US continues to struggle as evidenced by the sharp decline in the NASDAQ yesterday, although the DJIA managed to gain 0.5%.  In Asia, though, tech concerns were overwhelmed by the excitement of the BOJ’s action and the strength in the yen.  Perhaps the surprising thing is the Nikkei (+1.5%) rose so much given a strong yen generally undermines the index, but the rate hike boosted bank shares by 5% or more across the board.  And that strong yen was welcomed everywhere else in Asia with Chinese shares (Hang Seng +2.0%, CSI 300 +2.2%) and almost every regional exchange gaining real ground on the back of a less competitive Japan given the higher yen.

In Europe, most markets are much firmer as well this morning, led by the CAC (+1.4%) and FTSE 100 (+1.4%) although Spain’s IBEX (-1.0%) is lagging on uninspiring corporate earnings results.  I would contend these markets are being helped by that stronger yen as well, given Japan’s status as a major exporter.  Lastly, US futures are higher at this hour (7:20) after some better-than-expected results from chipmaker AMD, although MSFT’s numbers were less impressive.  Net, though, NASDAQ futures are up 1.6% this morning dragging everything else along for the ride.

In the bond market, Treasury yields continue to edge lower, down -1bp this morning and European sovereign yields are all lower by between -2bps and-3bps.  That is somewhat interesting given the flash Eurozone inflation data printed higher than expected at 2.6% headline, 2.9% core, but the market is clearly going all-in on the rate cutting narrative.  The big moves in this market, though, came in Asia with JGB yields jumping 5bps after the rate hike and the BOJ’s announcement they would be reducing their monthly purchases by 50%…OVER THE NEXT TWO YEARS!  They are not exactly rushing to tighten policy.  However, even more impressive was the -16bp decline in Australian 10yr bond yields after softer than expected inflation data overnight got the market thinking about rate cuts instead of the previous view of rate hikes being the next move.

In the commodity markets, things have really broken out.  Oil (+3.5%) is finally paying attention to the escalation of hostilities in the Middle East after Hamas leader Haniyeh was killed while in Iran.  While Israel has not officially claimed the act, that is the assumption and concerns are elevated that there will be a more dramatic response impacting many oil producing nations.  This has encouraged the rally in precious metals with gold (+0.4%) continuing its rally after a >1% gain yesterday, and support for both silver and copper as well.  Frankly, the copper story doesn’t make that much sense given the ongoing lackluster economic growth story, but with the metal’s recent sharp decline, this could simply be a trading bounce.

Finally, the dollar is all over the place this morning.  As mentioned above, the yen is today’s big winner, but we have seen strength in CNY (+0.25%) and KRW (+0.85%) as well, with both those currencies directly aided by yen strength.  Meanwhile, AUD (-0.5%) has responded to the quickly evolving rate story Down Under and is cementing its position as the worst performing G10 currency in July.  Not surprisingly, the commodity linked currencies are having a good day with ZAR (+0.6%) and NOK (+0.5%) both stronger, but after that, the financially linked currencies are not doing very much, so the euro, pound, Loonie and Swiss franc are all only marginally changed on the day.

In addition to the ADP and the FOMC, this morning also brings the Treasury’s QRA, although there is little interest in that report this time around as expectations remain that there will be no major change to the recent mix of debt, i.e., mostly T-bills.  We also see Chicago PMI (exp 44.5) and get the EIA oil data, although the latter will have a hard time competing with a pending war in the Middle East.

All told, not only has a lot happened, but there is also room for a lot more to occur before we go home today.  Quite frankly, I don’t see anything extraordinary coming from Powell, but the risk, to me, is he is more dovish than required and the dollar falls more broadly while commodity prices rise.  Keep your eye on that 150 level in USDJPY, as a break there can really get things moving.

Good luck

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German Malaise

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With central bank meetings ahead
Tonight BOJ, then the Fed
The discourse today’s
On German malaise
And why vs. the PIGS its widespread
 


As investors await the news from Ueda-san tonight and Chairman Powell tomorrow, the market discussion has revolved around the potential problems that Madame Lagarde is going to have going forward given the split in economic outcomes within the Eurozone.  As can be seen in the below graph, German GDP growth (grey bars) has been running at a negative rate for the past 4 quarters.  But you can also see that the situation in both Spain (red bars) and Italy (blue bars) has been the opposite, with both of those nations maintaining a steady pace of growth.

 

Source: tradingeconomics.com

So, while Germany is the largest single economy within the Eurozone, its current trajectory is very different than much of the rest of the bloc, ironically specifically the PIGS.  Should the ECB ignore German weakness and manage monetary policy toward the overall group?  Or should they ease more aggressively in order to support the Germans while risking a rebound in still sticky inflation?

Perhaps the first thing to answer is why Germany has been suffering for so long. This is an easy question to answer. Germany’s energy policy, Energiewende, has been an unmitigated disaster.  Their efforts to address climate change have led to the highest energy costs in Europe which, not surprisingly, has resulted in a massive reduction in manufacturing activity.  Areas where Germany had been supreme, like chemicals and autos, are hugely energy intensive industries, so as their cost of production rose, the companies moved their activities elsewhere.  Adding to the insanity was the policy to shutter their nuclear fleet, which had produced 10% of the nation’s electricity, during the post Ukraine invasion energy crisis.  And ultimately, this is the problem.  The cost of money is not Germany’s economic problem, it is their policies which have undermined their own growth ability.  While the ECB cannot ignore Germany outright, there is nothing they can do that will help the nation rebound in any meaningful way.  With that in mind, I would contend Lagarde needs to focus on the rest of the bloc to make sure policy suits them.  But that is a political discussion.

What are the likely impacts of this situation?  Eurozone growth, overall, surprised on the high side despite the lagging German data.  As well, inflation readings released thus far this month have shown that prices remain sticky on the continent.  With that in mind, the idea the ECB needs to cut aggressively seems to make little sense.  This is not to say they will maintain tighter policy, just that it doesn’t seem justified to ease.  But right now, the market zeitgeist is all about easing monetary policy (except in Japan) so I expect they will do just that going forward.  With this in mind, it strikes that the euro (+0.15%) is going to struggle to rally from current levels absent a dramatic shift in Fed policy to aggressive rate cuts.  As to European bourses, I suspect that they will reflect each nations’ own circumstances, so the DAX seems likely to lag going forward.

Will he, or won’t he?
Though inflation’s been falling
Hiking pressure’s real
 
A quick thought regarding tonight’s BOJ meeting and whether Ueda-san believes that further rate hikes are appropriate for the Japanese economy.  As with many things Japanese, the proper move is not necessarily the obvious one.  A dispassionate view of the recent data trends shows that inflation (2.8%) has been sliding slowly, GDP growth (-0.5%) has been falling more quickly and Unemployment (2.5%) remains at levels consistent with the economy’s situation given the shrinking population.   On the surface, this does not seem like a situation where hiking is desperately needed except for one thing, the yen remains broadly weak.  The chart below shows that since the advent of Abenomics in 2011, the yen has lost 50% of its value. 

 

Source: tradingeconomics.com

Now, initially, that was a key plank of the Abenomics platform, weakening the yen to end deflation.  Well, kudos to them, 13 years later they have achieved that result.  But where do they go from here?  There is a growing belief that the BOJ is going to hike by 15bps tonight and bring their base rate up to 0.25%.  I disagree with this theory given the very clear recent direction of travel in the inflation data in Japan as despite the yen’s weakness, it dispels any notion that a rate hike is needed to push things along.  One positive of the weak yen is that the balance of trade has returned to surplus in Japan.  

Source: tradingeconomics.com

For decades, Japan ran a large positive trade balance but since the GFC, that situation has been far less consistent.  However, the trade balance remains an important domestic signal as to the strength of the economy and its recent return to surplus is welcomed by the Kishida government.  It is not clear how raising interest rates will help that situation.  Net, with inflation sliding and the economy under pressure, hiking interest rates does not make any sense to me.

Ok, let’s take a look at how markets have behaved overnight.  Yesterday’s lackluster US equity market performance was followed by very modest strength in Japan (+0.15%), although weakness throughout the rest of Asia with the Hang Seng (-1.4%) the laggard, although mainland Chinese (-0.6%) and Australian (-0.5%) shares also suffered.  Meanwhile, in Europe this morning bourses on the continent are higher by about 0.4% across the board after the Eurozone GDP data seemed to encourage optimism.  The UK (FTSE 100 -0.2%), however, is under a bit of pressure amid ongoing discussions in the new Labour government about the need for austerity.  At this hour (7:20) US futures are edging higher by about 0.25%.

In the bond market, after yesterday’s sharp decline in yields around the world, it has been far less exciting with Treasury yields edging down another basis point and European sovereigns either unchanged or 1bp lower.  Perhaps the most interesting things is that JGB yields fell 2bps overnight and the 10yr yield is now back below 1.00%.  That doesn’t seem like a market preparing for a rate hike there.

In the commodity space, everybody still hates commodities with oil (-0.5%) continuing its recent slide.  In fact, it is down nearly 10% in the past month (which is good for us as we refill our gas tanks).  In the metals markets, copper continues to slide, down another -1.5% this morning as optimism over economic and manufacturing activity around the world remains absent, especially in China.  For instance, the Politburo there met yesterday and pledged to help the domestic economy, although they did not lay out specific actions they would take.  Recall last week’s Third Plenum was also a disappointment, so until the market perceives China is back and growing rapidly, or that the global growth impulse without them is picking up, it seems that industrial metals will remain under pressure.  Gold (+0.4%) however, remains reasonably well bid as continued Asian central bank buying along with retail interest in Asia props up the price.

Finally, the dollar is generally under modest pressure although the outlier is the yen (-0.6%) which does not appear to be expecting a BOJ hike tonight.  But elsewhere, the movements in both the G10 and EMG blocs have been pretty limited overall, on the order of 0.15% – 0.35%.  It is hard to find an interesting story about any particular currency as a driver today.

On the data front, this morning brings the Case-Shiller Home Price Index (exp +6.7%), JOLTs Job Openings (8.0M) and the Consumer Confidence Index (99.7).  I keep looking at that Case-Shiller index and wondering when the housing portion of the inflation readings is going to decline given its consistent strength.  But really, I suspect that all eyes will be on Microsoft’s earnings this afternoon along with the other hundred plus names that are reporting today.  With the Fed coming tomorrow, macro is not important right now.  So, more lackluster trading seems the most likely outcome today, although with the opportunity for some fireworks starting around midnight when the BOJ statement comes out.

Good luck

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Quite Vexatious

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The data remains quite vexatious
As some shows that growth is bodacious
But other releases
Are closer to feces
Implying the first stuff’s fallacious
 
For instance, the GDP print
At two point eight offered no hint
Recession is nearing
Yet stocks aren’t cheering
For bears, in their eyes, there’s a glint
 
But Durable Goods was abysmal
At minus six plus, cataclysmal
And more survey data
Implied that pro rata
The story ‘bout growth’s truly dismal

 

In the past week, we have seen a decent amount of data, and the upshot is that there is still no clarity on the US economic condition.  Many analysts accept the data at face value, and with today’s GDP print as the latest installment, dismiss the idea of a recession coming soon.  Others look at the headline, and then the underlying pieces and detect that ‘something is rotten in Denmark the US’.

 A quick review of the recent data shows the housing market is weakening further, with both New and Existing Home Sales declining on a monthly and annual basis.  As well, the Survey data showed the Richmond and Kansas City Fed’s Manufacturing Indices falling deeper into negative territory as well as a weak Flash PMI Manufacturing print.  Durable Goods headline fell -6.6%, which while it is a volatile series (depending largely on airplane deliveries by Boeing), was still a terrible outcome.  Absent transports, though, it rose 0.5%, which seems more in line with the first look at Q2 GDP, showing a 2.8% annualized growth rate.  (One thing to watch in that GDP report is the PCE index that is implied and showed a surprising rise.  Keep this in mind for tomorrow’s PCE report.). Alas, final Sales in the GDP report only rose 2.0%, a potential harbinger of future weakness.  

If we go back and look at the CPI data, which was soft, or the NFP data, which was strong, there continue to be underlying pieces of almost every report which indicate weakness compared to headline strength or vice versa.  So, which is it, recession or no?

Unfortunately, we will not know until the next recession has likely finished given the NBER’s methodology of declaring a recession.  (It is important to understand in the US, the rule of thumb, two consecutive quarters of negative real GDP growth is not the definition.)  Regardless, we haven’t even had one quarter of negative growth.  This poet’s view is that the economy is clearly slowing down with respect to activity but does not seem like it has yet tipped into recession.  Perhaps things will be clearer in Q3, but for now, the arguments are going to continue.

Tokyo prices
Keep on decelerating
Why will they tighten?

Tokyo CPI data was released overnight and once again, it was a touch softer than expected with both headline and core printing at 2.2%.  In fact, the ex-food & energy index rose only 1.1% Y/Y!  The Tokyo data is typically a harbinger of the national number and when looking at the data, it is easy to understand why Ueda-san is reluctant to tighten further.  As per the chart below, the trend here remains toward lower inflation without any further policy adjustments.  

Source: tradingeconomics.com

So, why would they move next week?  This is especially so given the yen has rebounded nearly 6% over the past several weeks, relieving pressure on the biggest current concern.  I know it is fashionable to think that the BOJ is going to tighten policy while the Fed cuts, but it is not difficult to make the case that the US economy is continuing to tick along and so higher for longer remains appropriate, while in Japan, price pressures are easing without any further policy tightening.  There is increasing analyst discussion the BOJ is going to move, but I remain suspect, at least at this point.  Rather, I expect that there is probably more short-covering to come in the JPY and that is going to further relieve pressure on the BOJ to act.

This morning, we get PCE
The data most pundits agree
Will license the Fed
To cut rates ahead
At least that’s the stock market’s plea
 
The final big story today is the release of the PCE data.  As we all know by now, this is the inflation metric the Fed uses in their models.  Current median expectations are as follows: Headline (+0.1% M/M, 2.5% Y/Y) and Core (+0.1% M/M, 2.5% Y/Y).  In both cases, that would represent a tick lower in the annual number compared to last month, and based on the current narrative, would add to the Fed’s confidence that inflation is coming under control.  And maybe that will be the case.  After all, the past two inflation reports have come in below the median expectations. 
 
However, there is another PCE report that is published alongside the GDP data.  Essentially, it is the number that determines how much of nominal GDP is actual growth and how much is price growth.  As part of yesterday’s GDP release, the core PCE index rose at a 2.9% rate, lower than Q1 but above expectations.  I’m merely pointing out that as seen above, there is a lot of conflicting data out there.  It would be premature to assume that inflation is under complete control in my view, although that is the growing market belief.
 
Ok, let’s look at what happened overnight.  Equity markets are trying to figure out what everything means right now.  Yesterday’s US performance was mixed, with Tech stocks still under pressure although the DJIA managed to gain on the day.  Overnight, Japanese stocks (-0.5%) continued their recent decline, following the NASDAQ lower, but both Hong Kong and China managed small gains on the session.  As to Europe, most major indices are in the green led by the CAC (+0.85%) despite the terrorist attacks on the high-speed rail network as the Olympics begin there.  But after several down days, investors feel like the correction has run its course and are coming back.  This is evidenced by US futures which are higher by upwards of 1% at this hour (6:30).
 
After yesterday’s more aggressive risk-off session, this morning bond yields are little changed to slightly higher around the world.  Treasuries are unchanged and European sovereigns have seen yields rise by either one or two basis points.  JGB yields, too, are higher by 1bp, as it appears investors have been exhausted by this week’s volatility.  Of course, a surprising number this morning will almost certainly get things moving again.
 
In the commodity markets, oil, which managed to rebound at the end of the day yesterday, is lower by -0.4% this morning.  Given the volatility across all markets right now, it is difficult to come up with a coherent story about the situation here in the short run.  Gold (+0.4%) which got decimated yesterday, has run into technical support and is rebounding, but the same is not true for silver or copper, both of which remains near their recent lows.  I will say this about copper; as it remains one of the most important industrial metals, its weakness does not seem to bode well for economic growth going forward, and yet as we saw yesterday, US GDP is running above trend.  This is simply more evidence that confusion reigns in market views.
 
Finally, the dollar is generally lower this morning. While the yen (-0.55%) is giving back some of its recent gains, almost all of the other major currencies in both the G10 and EMG blocs are a touch stronger.  MXN (+0.7%) is the leader followed by ZAR (+0.5%) with most others gaining much smaller amounts.  The thing is, aside from the US data, there has been precious little other data of note that would drive things.  One might make the argument that the rebound in gold is helping the rand, but that seems tenuous.  Right now, with risk being re-embraced, my take is the dollar is simply softening a bit.
 
In addition to the PCE data we also see Personal Income (exp 0.4%) and Personal Spending (0.3%) and then at 10:00 we get the Michigan Sentiment Index (66.0).  But all eyes will be on PCE.  I look at the GDP data and think we could see something a bit hotter than currently forecast and desperately hoped for.   If that is the case, I suspect that stocks may falter and bonds as well although the dollar should regain ground.
 
Good luck and good weekend
Adf
 
 

Destined for Sloth

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The Chinese are starting to worry
That if they don’t act in a hurry
Their ‘conomy’s growth
Is destined for slowth
Explaining their rate cutting flurry

 

Sunday night, the PBOC surprised markets by cutting both their 1-year and 5-year Loan Prime Rates by 10 basis points each.  As well, they cut the rate on their newly developed 7-day repo rate by 10bps as they endeavor to shorten the maturity of their money market operations. At the time, it was taken as a response to the Third Plenum and the only concrete action seen as new support for the economy.  As its name suggests, those rates represent the cost to borrow for credit worthy companies.  A quick look at the history of this rate (the blue line), which was first tracked toward the end of 2013, shows that over time, it has done nothing but decline.  I have overlayed a chart of USDCNY in the chart (the grey line) to help appreciate the long-term trend in that as well which, not surprisingly, shows a steady weakening of the renminbi (rise in the dollar).

Source: tradingeconomics.com

But the reason I bring this up is that last night, the PBOC surprised markets yet again by cutting its One-Year Medium-Term Lending Facility by 20 basis points, to 2.30%.  Not only was this the largest cut since the pandemic, but it was also done at an extraordinary meeting and combined with an injection of CNY235 billion (~$32B) into the economy.  Arguably, this is the most aggressive monetary policy stance that has been effected by the PBOC since the summer of 2015 when they surprisingly devalued the renminbi 2%.  Apparently, the PBOC is trying to adjust its policy actions to be more in line with the G7 where central banks use short term rates as their tools.  One other thing this implies is that President Xi remains steadfastly against any fiscal stimulus of substance at this point.  On the one hand, you must admire that effort, but I fear that the domestic Chinese economy remains so weighed down by the ongoing property sector problems, achieving their 5.0% GDP growth target is going to become that much more difficult as the year progresses.

For our purposes, though, the story is all about the CNY (+0.7%), which rallied sharply after the announcement, continuing its movement from the Monday rate cuts which totals 1.1%.  Now, ordinarily one might think that a country cutting its rates would lead to a weaker currency, ceteris paribus, However, given the market outcome, there is much discussion about how the PBOC “requested” Chinese banks to more aggressively buy CNY to support the currency.  Interestingly, the fixing rate on shore overnight (7.1321) continues to weaken ever so slightly overall, but now the spread between the fix and the market has fallen to just over 1%, well within the +/- 2% band and an indication there is less pressure on the currency.  My take is this is just window dressing, but I would not fight it.  I expect that we will see USDCNY slowly return to higher levels over time, with the key being it will take lots of time.

The ongoing rout
In tech stocks has another
Victim, dollar-yen

Under the guise, a picture is worth a thousand words, the below chart showing the NASDAQ 100 (blue line) and USDJPY (green line) overlaid is quite interesting.

Source: Tradingeconomics.com

While there is an ongoing argument amongst market practitioners as to whether it is the decline in the tech sector that is driving USDJPY’s decline or the other way round, what is clear is that there is a strong correlation between the two.  If you think about what the USDJPY trade represents, it is the purest form of a carry trade, shorting the cheapest currency and using the funds to buy a much higher yielding currency with maximum liquidity.  But another thing to do with those funds obtained from borrowing yen and buying dollars was to use the dollars to jump on the tech stock bandwagon.  After all, that added another 30% to the trade since the beginning of the year.  

However, over the past two weeks, nearly one-third of the NASDAQ gains have been erased and that has been made worse by the >6% rise in the yen.  At this stage, it no longer matters which is driving which, the reality is that we are seeing significant short covering in the yen with sales in other assets required to unwind the trade.  Arguably, this is why we are seeing virtually every risk asset lower this morning, although bonds are holding up as havens, as all have been funded with short yen.  Given that relationship, I am coming down on the side of the yen being the driver, but as I said, I don’t think it matters.  

The real question is can it continue?  It is important to understand that when markets achieve excessive levels like we saw in USDJPY, they rarely simply unwind to some concept of fair value.  Rather they typically overshoot dramatically in the other direction.  As such, if we assume PPP is fair value, and PPP for USDJPY is currently around 110.00, it appears there is ample room for USDJPY to decline much further.  Consider, this movement has happened, and the Fed has not even started to cut rates.  If we do, indeed, fall into recession, the Fed will respond, and I expect that we could see a very sharp decline in USDJPY.  Something to consider looking ahead.

While that was a lot about the currency markets, they seem to be the current drivers, so are quite important.  But let’s look at everything else.

Equity market pain has been universal with Japan (-3.3%), Hong Kong (-1.8%) and China (-0.6%) all following the US lower overnight and in Europe, this morning, it is no better with the CAC (-2.2%) the worst performer, but all the major indices falling sharply.  US futures are little changed at this hour (7:00), but remember, we are awaiting key GDP data and more earnings numbers, which have been the driver.

As mentioned above, bond markets are rallying with Treasury yields lower by 5bps and most European sovereigns seeing declines of -3bps or -4bps.  Credit is an issue as Italian BTPs are the laggard this morning, with yields there only lower by 1bp.  Equally of interest is the fact that the US yield curve inversion has been reduced to just 14bps and has been normalizing dramatically for the past several sessions.  One thing to remember about the yield curve is that when it inverts, it indicates a recession is coming, but when it uninverts, it indicates the recession has arrived!  This is all of a piece with softer economic data and expectations of Fed policy ease coming soon to a screen near you.

In the commodity markets, nobody wants to own anything.  Oil (-1.3%) is continuing its recent poor performance despite EIA data showing significant inventory reductions.  This is not a sign of strong demand.  But we are also seeing weakness across the entire metals space with gold (-1.0%) breaking back below $2400/oz and silver and copper under severe pressure.  Right now, nobody wants to hold these, although I suspect that the long-term supply/demand situation remains bullish.

Finally, the dollar is mixed overall.  While we have seen strength in JPY and CNY, as discussed above, and CHF (+0.8%) is also showing its haven status and use as a funding currency, there are numerous currencies under pressure, notably AUD (-0.8%), NOK (-0.8%), MXN (-0.8%), ZAR (-0.7% and SEK (-0.6%) all of which are commodity linked to some extent.  Yesterday, the BOC cut rates by 25bps, as expected, but the Loonie has been steadily weakening for the past two weeks, so yesterday’s decline and today’s is just of a piece with that.  Ultimately, we are watching a serious risk-off event, and I expect the dollar will hold its own vs. most currencies, although JPY and CHF seem to have room to run yet.

On the data front, once again yesterday’s data was on the soft side with the Flash Manufacturing PMI falling to 49.5, well below expectations and New Home Sales slipping to 617K.  In fact, it is difficult to find the last strong piece of data, perhaps the ex-autos Retail Sales number from last week.  This morning, we see Initial (exp 238K) and Continuing (1860K) Claims, Q2 GDP (2.0%), and Durable Goods (0.3%, 0.2% ex transport).  The Atlanta Fed’s GDPNow tool is indicating GDP in Q2 was 2.6%, well above the forecasts.  However, I think of much more interest will be to see how it starts out for Q3.  We have had a spate of weak data, and those recession calls are growing louder.

This is a tough market, but I expect we have not yet seen the last of the risk-off trade (just consider how long the risk-on trade has been going on) so further dollar strength against most currencies, except for JPY and CHF, and further weakness in commodities and equities seem the most likely direction.

Good luck

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No Choice

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Data indicates
The BOJ intervened
Did they have no choice?

 

Last night, Masato Kanda, the Vice Minister of Finance for International Affairs, colloquially known as Mr Yen explained, “I have no choice but to respond appropriately if there are excessive moves caused by speculators.”  He also explained, “We are communicating very closely with the authorities of each country and complying with international agreements, so there has been no criticism from other countries.”  In other words, while he did not actually come out and say that the BOJ intervened on behalf of the MOF, it seems pretty clear that is the case.  Certainly, a look at the price action again last night, as per the below chart, shows that is a viable reality.

Source: tradingeconomics.com

You may recall that USDJPY fell sharply in the wake of the CPI data last week and there was substantial question as to whether there was intervention at the time.  My view was the BOJ would not have been able to act on a timely basis and attributed the move to an overly long dollar positioned market and some algorithmic selling.  However, it appears that data from the BOJ’s accounts have since been released showing approximately ¥6 trillion (~$38.4 billion) was spent at the end of last week.  Now, given the Kanda comments above, the reality is that the MOF is drawing a line in the sand at 162.  

In fairness, this seems a propitious time to do so given the growing certainty that the Fed is finally going to begin its policy easing.  Of course, the main reason that the yen had weakened so much is that, not only had the interest rate differential widened substantially, allowing for, and even encouraging, the growth of the ‘carry trade’ where investors were happy to simply hold long forward USDJPY positions and wait for the time to pass and the profits to roll in.  But as well, there was no indication that the Fed was going to change its stance while the BOJ, though it had threatened to begin tightening policy, was doing so at a glacial pace.  However, that CPI number has dramatically altered opinions, not only of the trading community, but more importantly, of the Fed.  All the Fed comments we have heard since that data point have indicated a much greater willingness to consider easing policy.  Talk about both the goods and labor markets coming into balance are indicators they are ready to roll.  

We still have seven more Fed speakers this week ahead of the quiet period and I would wager that to a (wo)man, they will all say their confidence is growing that price pressures are receding, and they are watching the employment situation carefully.  As I wrote yesterday, the CME Fed funds futures market is pricing a 100% probability of a 25bp cut in September with some folks looking for 50bps.  Given the totality of the recent data where the probability of a recession seems to be growing, I agree a September cut looks likely.  This is not to say every data point is going to be pointing to weaker economic activity (e.g., yesterday’s Retail Sales data was much stronger below the headline number), just that will be the broad trend.

In this situation, with the market starting to believe that higher for longer is truly dead, the initial reaction will be for further dollar weakness.  Of course, once it is clear the Fed has begun to ease policy, we will see other central banks increase their pace of policy ease at which point the dollar’s decline will likely slow or stop.  Remember, FX is a relative game, so if everybody is easing policy at the same time, those interest rate differentials are not going to change very much at all.  However, commodity prices, especially precious metals prices, are likely to be the biggest beneficiaries.  As to stocks and bonds, the former have a much less certain path given the impact of declining inflation on profits, especially for the mega cap names, but bonds should perform well (yields declining) at least as long as inflation remains tame.  Just beware of a slow reversal of the inflation story.  Nothing has changed my view that 3.0% is the new 2.0%.

Aside from the yen news, last night was decidedly lacking in new information.  We saw UK inflation data print at the expected levels showing it has fallen back close to their target of 2%.  We saw final Eurozone inflation also confirming a 2.5% inflation rate.  While the ECB has essentially ruled out a rate cut tomorrow, a September cut seems highly likely at this time, especially if they have confidence the Fed is going to cut then as well.

So, let’s look at the overnight session.  After more record highs in the US, with the DJIA approaching 41K, the tone in Asia was more mixed.  Japanese shares (Nikkei -0.4%) fell as the yen’s strength continues to hamper profit expectations for the many exporters in the index.  Chinese shares, both in Hong Kong and on the mainland, edged higher by less than 0.1% as investors continue to wait to hear the results of the Third Plenum.  As to the rest of the region, gains in Australia and New Zealand were offset by losses in South Korea with most other markets little changed.  however, in Europe this morning, the screens remain red with losses across the board, albeit not as significant as we have seen in the past several sessions.  The DAX (-0.4%) is the laggard although all the major markets are lower.  Finally, at this hour (7:20), US futures are suffering led by the NASDAQ (-1.5%) although they are all under pressure.  It seems that the story about increased tariffs on Chinese goods as well as a ban on selling additional semiconductors to China doesn’t help the prospects of semiconductor companies that rely on China for their sales.

Interestingly, the bond market has seen yields edge higher this morning with Treasuries higher by 2bps and most of Europe up by 1bp.  Given the small size of the movement, I wouldn’t attribute much fundamental thought to today’s price action, and after all, 10-year Treasury yields have fallen 30bps since the first of the month, so a lack of continuation is not that surprising.

In the commodity markets, oil (+0.5%) is rebounding after a rough couple of days.  The weakening economy story is weighing on perceived demand and there is ample supply around.  Gold (+0.1%) is continuing to rally after closing at another all-time high yesterday while silver (-0.9%), which followed gold yesterday, is giving back a bit this morning.  Industrial metals are little changed this morning as they await further confirmation of the economic situation.

Finally, the dollar is under pressure this morning, falling substantially against almost all of its major counterparts, both G10 and EMG.  Aside from the yen (+1.1%) which we discussed above, the pound (+0.5%) is leading the way along with SEK (+0.6%) although the euro (+0.35%) is also firm.  In fact, the pound has risen above 1.30 for the first time in a year while the euro pushes the top of its 1.0650/1.0950 2024 trading range.  The laggard in the G10 space is CAD, which is unchanged on the day as market participants tie its performance directly to the dollar and anticipate the BOC to match the Fed going forward.  In the EMG bloc, though, there are two outliers which have suffered today, despite the dollar’s broad weakness, MXN (-0.6%) and ZAR (-0.7%).  The peso seems to be feeling the effects of weaker than expected economic data lately which has put Banxico into a difficult position as inflation remains above their target.  Will they cut to support the economy and undermine the currency?  That is the question.  As to the rand, aside from its status as the most volatile currency, the market seems to be reacting to a sharp decline in Retail Sales last month, -0.7%.

On the data front, this morning brings Housing Starts (exp 1.3M), Building Permits (1.4M), IP (0.3%) and Capacity Utilization (78.4%) along with the EIA oil inventories.  In addition, we will hear from Richmond’s Thomas Barkin and Governor Waller and then at 2:00 the Fed’s Beige Book will be released.  The current market narrative has quickly shifted to rate cuts, and more tariffs.  The upshot is the dollar is likely to remain under pressure while equities will have a more difficult time going forward.  If inflation remains quiescent, then bonds can do well, but the big winner through it all should be commodities.

Good luck

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