Tag Archives: #JPY

Equity’s Epitaph

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Each day as more data arrives
And pundits perform their deep dives
The talk of recession
Has forced some to question
How anyone bullish survives
 
But stock bulls have had the last laugh
Just look at a stock market graph
However, fixed income
Has started to look glum
Is this equity’s epitaph?
 
The only thing one can say about the recent data is that there is no clear direction of travel.  For instance, in the past week we have seen better than forecast results from Consumer Confidence, Durable Goods, Chicago PMI and Michigan Confidence while the Richmond Fed, New Home Sales. Building Permits, Personal Income and ISM Manufacturing all printed on the soft side of things.  The biggest data point, PCE, was essentially right on the money, so didn’t alter this equation.  However, perhaps the best way to sum up this mix of data is to look at the Atlanta Fed’s GDPNow calculation, and as can be seen in the chart below, it is heading lower.

 

Source: Atlantafed.org

The history of this calculation is that early in the quarter, it has limited predictive ability, but as the quarter ends, which it just did on Friday, it becomes a much better predictor of the actual results to come.  If I were to characterize this statistic it shows that the economy is slowing down but is not yet looking at a recession.

Is this the fabled goldilocks outcome of a soft landing?  Perhaps, but personally, I have my doubts.  To explain, let’s discuss the yield curve for a moment.  As you are all well aware by now, when the yield curve inverts (short end rates are higher than long end rates) that has been a reliable indication that a recession is coming.  We continue to be in that situation and in fact, the current inversion between the 2yr and 10yr Treasury, one of the most common measures, has been inverted for a record long period, more than 16 months.  

However, one thing that is widely misunderstood about the yield curve signal is that it is not a description of a current recession, rather it is a harbinger of a future one.  That recession tends to be coincident with the steepening of the yield curve back to its more normal shape.  And the question right now is, will the yield curve steepen because the front end of the curve sees rates decline, a so-called bull steepener, or because the back end of the curve sees rates rise, a much more uncomfortable situation known as a bear steepener.  

The soft-landing view is that the former is in our future as the Fed will cut rates to help stabilize the economy while 10yr yields hang around the 3.5% – 4.0% level.  It certainly appears that has been a critical piece of the equity market bullish story.  However, the alternative, where long end rates rise despite economic weakness, seems equally probable right now, and based on the bond market’s moves over the past several sessions, may well be taking over the narrative.  In this situation, the Fed continues to see inflationary pressures as too great to ignore and maintains higher for longer.  At the same time, the fiscal profligacy that is evident right now, and shows no signs of ending regardless of the election outcome, starts to bite.  Investors demand ever higher yields to hold Treasuries for any extended length of time and the 10yr rises to 5.0% – 5.5% or higher.

While the Fed’s record of preventing a recession by cutting rates is quite poor (perhaps one positive outcome in their history in 1995), their record of seeing a recession hit when they don’t cut rates, or even raise them to fight stubborn inflation, is even worse.  While two days is not yet a trend, it is certainly important of us to watch how the bond market behaves.  If long end rates start to rise more aggressively, that would be a signal that investors are turning more negative on the future.  It is at this point where we will learn the answer to the question of exactly how the Fed’s reaction function works.  History has shown that the unemployment rate rises with bear steepeners, and that is what forces the Fed to respond by cutting rates.

However, remember, if inflation remains stubbornly high and the Fed decides to cut rates to address unemployment, I believe that is the worst of all worlds.  We would be in a weakening economy with high inflation and a Fed that is far behind the curve amid a government that is spending money with no limits.  In that scenario, which, alas, has a reasonably high probability of occurring, the dollar should decline, bonds will decline (yields rise), commodities will rally, and equities will likely start to rise, but as earnings falter, so will prices.  This is not where we want to go.

We are not there yet, so let’s look at how things played out overnight instead.  Japanese shares continue to rally (+1.1%) with the Nikkei reclaiming the 40K level.  This continues to be on the back of the uber-weak yen (discussed below) as so many companies are exporters and benefit from the weak yen.  However, Chinese shares did not fare as well, edging lower as investors begin to wonder what will come from the Third Plenum due to take place in two weeks’ time.  Elsewhere in the region, there was far more red than green on the screens.  The red seems to have been contagious as all of Europe is under water this morning, with most falling more than -1.0%.  This is not really a data story, rather this seems to be a re-evaluation of this weekend’s French second round elections and growing fears that Marine Le Pen and her RN party are going to win the day.  We just saw a right-wing party take power in the Netherlands and have seen the same throughout Scandinavia.  I continue to be baffled at why investors are more concerned regarding spending by right leaning governments than left leaning ones, but that is clearly the current situation.  As to US futures, at this hour (7:30) they are sliding by -0.45% or so.

Bond markets are consolidating after yesterday’s rout with Treasury yields unchanged this morning while most of Europe has seen yields edge higher by just one or two basis points.  However, global bond markets have been under pressure all this week and while today may provide a respite, I sense further stress to come.  JGB yields rallied 3bps overnight and are now at their highest level since July 2011.  Alas, these higher Japanese yields have not helped the yen.

In the commodity markets, oil (+0.7%) continues to rally although the current story is focused on Hurricane Beryl which is heading into the Caribbean and the Gulf of Mexico and likely to shut in some offshore production there for a while, reducing supply.  However, precious metals are under pressure amid a rising dollar though copper (+0.6%) is holding its own on inventory concerns.

Finally, the dollar is firmer this morning against virtually all its counterparts in both G10 and EMG blocs.  The euro (-0.15%), which had rallied a bit on Monday amid hopes that the RN would not capture a majority in France, has given that back as the story ebbs and flows.  But really, JPY (-0.1% today, -1.2% in the past week) is the story as traders gain confidence that the MOF is not ready to respond yet and with US yields climbing, the carry trade continues to be extremely attractive.  Today’s dollar rally is broad, but the large moves are limited with ZAR (-0.6%) the worst performer although there are numerous currencies that have slipped -0.25% or so.  But it’s a dollar thing today.

On the data front, today only brings JOLTS Job Openings data (exp 7.91M) although perhaps more importantly, we hear from Chairman Powell this morning at 9:30.  The thing is, I don’t see any reason for him to have gained confidence that inflation is reliably heading back to target, and until we see Friday’s payroll report, there is no reason to believe that they are concerned about that.  In fact, that brings up the issue that Friday’s data release is likely to be extremely important to the narrative and has the chance to be quite disruptive given the high likelihood that staffing across all desks in the US will be light.  Remember, too, that the UK election will be held on Thursday, so more change is afoot.

Right now, the dollar seems healthy, but there is much to be learned this week and it will help inform how things evolve.

Good luck

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The Fat Lady

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Is the fat lady
Starting to sing?  Listen for
More threats to be sure

 

Tell me if you’ve heard this one before, “It’s desirable for exchange rates to move stably. Rapid, one-sided moves are undesirable. In particular, we’re deeply concerned about the effect on the economy.”

Or this one, “We are watching moves with a high sense of urgency, analyzing the factors behind the moves, and will take necessary actions.”

Of course, the answer is yes, these are essentially verbatim of what Shunichi Suzuki, Japanese FinMin, said earlier this week, as well as several times back in April prior to their last bout of intervention.  It is probably step 3 on the 7-step program that leads to eventual intervention by the MOF/BOJ.   And those are his direct comments from last night in the wake of USDJPY trading to yet another new high (160.88) for the move.  The last time the currency was that weak vs. the dollar was in 1986.  

Now, perhaps I can help him analyze the factors behind the moves.  Why look, the entire interest rate complex in Japan remains significantly below the same metrics anywhere else in the world, but from a G10 perspective, specifically vs. the US.  As well, the commentary from the various Fed speakers we have heard just this week continues to indicate higher for longer remains the play.  Recall, Governor Bowman even suggested the possibility of raising rates if circumstances dictated.  I might suggest to Suzuki-san, that as long as the BOJ maintains ZIRP, and continues to hold 50% of the JGB market, the yen will remain under pressure. 

The question remains, just how high can USDJPY go?  And the answer remains much higher.  I continue to believe that we will need to see a quick move to 163, at least, before the MOF tries to slow things down again, meaning by Monday latest.  If, instead, the market simply hangs around at this new level, I expect more jawboning but no action.  The one caveat is that next Thursday is July 4th, when all banks in NY will be closed and market liquidity will be extremely suspect.  It would not be a surprise if they were to take advantage of those thin markets and aggressively sell dollars then.  It would certainly have an outsized impact.  We shall see.

Today’s likely to be at peace
As folks eye tomorrow’s release
Of PCE data
And so, options’ theta
Is vanishing like Credit Suisse

The truth is, away from the yen story, there is very little of consequence ongoing as the market sets its sights on tomorrow’s PCE data.   This evening’s Presidential debate will certainly be interesting and likely be entertaining, but it is not clear it will impact markets.  And while we continue to see gyrations in various markets, the big themes remain stable.  The Fed is not about to change its stripes as we have heard repeatedly since the FOMC meeting, the economy continues to move along, albeit at a somewhat slower pace than Q1, but not showing any hint of recession at this stage, and the geopolitical situation is constant with Russia/Ukraine and Israel/Gaza continuing to wreak havoc and destruction mostly in the background.  As such, I expect that we are going to be subject to more idiosyncratic movements in markets for now.
 
So, let’s look at what happened overnight.  After yesterday’s very limited equity moves in the US, most of Asia was in the red led by the Hang Seng (-2.1%) as tech shares were under pressure.  But the Nikkei (-0.8%) and Shanghai (-0.75%) also fell with the former a bit surprising given both the weaker yen and the surprisingly better than expected Retail Sales data released, while the latter seemed to respond to declining Industrial Profit data that was released.  As it happens, Australia shares were also softer as inflation data there continues to show stubborn strength squashing any ideas of an RBA rate cut soon.  In Europe, red is also the most common color with the CAC (-0.5%) and IBEX in Spain (-0.5%) leading the way lower.  Most other markets are softer although the DAX (+0.1%) is bucking the trend, despite lacking an obvious catalyst for the move.  And let’s face it, 0.1% is not really relevant to anything.  At this hour (7:00), US futures are pointing slightly lower ahead of the weekly Claims data.
 
In the bond markets, yields in the US backed up by 5bps and have stayed there this morning.  in Europe, the markets closed before the US move finished, so this morning, yields across the continent are higher by 3bps or so as they catch up to the US.  In Asia, the movement was stronger with JGBs +5bps and Australian bonds +10bps on the back of the US move as well as Australia’s growing inflation concerns (Consumer Inflation Expectations rose to 4.4%).  It strikes me, looking at the chart below, that yields have been in a wide range, about 90 basis points, for the past year and that we are currently pretty much in the middle of that range.  It is hard to get too excited about things until we break this range in my view.

Source: tradingeconomics.com

In the commodity space, oil (+0.35%) is rebounding slightly this morning after weakness in the wake of larger than expected inventory data released yesterday, with an over 6-million-barrel increase compared to expectations of a 5.5-million-barrel drawdown.  As to the metals markets, gold (+0.7%), which suffered on the back of the strong dollar yesterday, is rebounding and taking silver with it, although the industrial metals remain under pressure.

Finally, the dollar, which was king of the hill yesterday, with the Dollar Index trading back above 106 for a while, is softening a touch this morning, probably about 0.2% or so against its major counterparts.  However, while that is the general result today, there is one outlier, ZAR (-1.15%) which continues to demonstrate remarkable volatility amidst the political situation with no cabinet yet named.  Perhaps the driver this morning was the softening inflation picture enticing traders to believe that SARB may be considering rate cuts soon.

On the data front, this morning brings the weekly Initial (exp 236K) and Continuing (1820K) Claims data along with Durable Goods (-0.1%, +0.2% ex Transport), final Q1 GDP (1.4%) and its components of note like Final Sales (1.7%) and its Price Index (3.3%).  Remarkably, there are no Fed speakers due today either.  I think we need to keep a close eye on the employment situation as it has been slowly worsening overall.  It wasn’t that long ago when Initial Claims were pegged at 212K every week.  Now they have grown by more than 20K and any lurch higher will be noticed.  Next week’s NFP is going to be critical with the potential for a significant impact as it will be released the day after the July 4th holiday, a day when trading desks will be very lightly staffed.

For today, it is hard to get excited about anything, but if we continue to see the slow deterioration of US data, that will eventually feed into the rate picture and the dollar’s value as well.

Good luck

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To Oblivion

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The yen continues
To grind ever so slowly
To oblivion

 

Well, for all those who were either concerned or anxiously awaiting USDJPY’s move to and above 160, we got there early this morning, and the world has not ended.  Not only that, but there is no sign of the BOJ/MOF, nor do I believe will there be for a while yet.  As I explained on Monday, history has shown, and the MOF has been explicit, that they are far more concerned with the pace of any movement in the currency, rather than the specific level at which it trades.  So this much more gradual decline in the yen, while potentially somewhat uncomfortable given its possible impact on inflation going forward, is just not alarming.  You can expect to hear Kanda-san or Suzuki-san reply when asked about the currency that they are watching it closely and prefer a stable currency, but I believe they are fairly relaxed about the situation this morning.

A look at the chart below from tradingeconomics.com shows the trend has been steady all year (which given the interest rate differential between the two currencies makes perfect sense) and that only when things accelerated back at the end of April did it generate enough concern for the MOF to act.  If we see another sharp movement like that, you can look for another round of intervention.  But, at the current pace, likely all we will get is some commentary about stable movement and vigilance.

Source: tradingeconomics.com

While many worldwide want to think
Inflation is starting to shrink
The data released
Shows it has increased
Down Under with Quebec in sync

With all eyes on Friday’s PCE data as a harbinger of the next Fed activity, it is worthwhile, I think, to mention what we have just seen from two other G10 nations regarding their inflation situation.  Starting north of the border, you may recall that earlier this month the Bank of Canada cut their base rate by 25bps in anticipation of achieving their 2% target given the prior direction of travel of their CPI statistics.  Oops!  Yesterday revealed that both the headline and core readings rose a much higher than forecast 0.6% in May, bringing the annual readings to 2.9% and 1.8% respectively.  As well, they focus on the Trimmed-Mean annual number, which also surprisingly rose to 2.9%.  now, one month does not a trend make, but Governor Macklem may have some ‘splainin’ to do the next time he speaks.  It is possible that inflation has not turned the corner after all.

Meanwhile, Down Under, the RBA must be feeling a bit better as they have maintained a more hawkish stance overall, arguably the most hawkish of any G10 member, and last night’s CPI reading of 4.0%, a 0.4% rise from the April data and 0.2% higher than forecast, is a reminder that inflation can be difficult to conquer for all central banks.  Since December, the readings Down Under had been in the low 3’s and many pundits were anticipating that the next leg was lower there as well.  Oops again!

With this in mind, it can be no surprise that the two Fed speakers yesterday, Bowman and Cook were both leaning toward the hawkish end of the spectrum.  In fact, Bowman even raised the possibility of future rate hikes as follows [emphasis added], “Reducing our policy rate too soon or too quickly could result in a rebound in inflation, requiring further future policy rate increases to return inflation to 2% over the longer run.”  At the same time (well actually, 2 hours earlier) Governor Cook did explain she sees rate cuts coming, just not the timing.  To wit, “With significant progress on inflation and the labor market cooling gradually, at some point it will be appropriate to reduce the level of policy restriction to maintain a healthy balance in the economy.  The timing of any such adjustment will depend on how economic data evolve and what they imply for the economic outlook and balance of risks.” 

It strikes me that no matter how you parse these comments, right now, there is no indication that pretty much anybody on the FOMC is considering rate cuts soon.  Futures markets have not really changed their pricing lately with a 10% probability of a July move and a 64% probability of a September cut.  However, one interesting tidbit is that in the SOFR futures options market, there has been a very substantial position building in March 2025 97.75 SOFR calls.  For these to pay off, Fed funds would need to fall about 300bps between now and March, far more than is discussed or priced right now.  While this could certainly be a position hedge of some sort, it does have many tongues wagging.

Ok, a review of the overnight session shows that we are still amid the summer doldrums overall, with some movement in markets, but nothing very dramatic and no real trends developing.  In Asia, the Nikkei (+1.25%) rallied on the back of the weak yen and is back approaching the 40K level, although a look at the chart shows simply choppy price action with no direction.  Hong Kong was flat, Shanghai (+0.65%) rose and Australia (-0.7%) fell on the back of that inflation data and the realization that the RBA is not cutting rates anytime soon.  In Europe, the movement has been weaker, rather than stronger, with French (-0.55%) and Spanish (-0.4%) shares both softer although German and UK shares are essentially unchanged today.  Finally, US futures are mixed with small gains for the NASDAQ and S&P while DJIA futures are following through on yesterday’s index declines.

In the bond markets, higher yields are the order of the day with Treasuries and virtually all of Europe higher by 3bps.  Overnight, JGBs saw a similar rise in yields which has now taken the 10yr yield there back above that 1.00% pivot.  The outlier here is Australia, which given the CPI data there, not surprisingly saw yields jump more, in this case by 11bps.

In the commodity markets, oil (+0.6%) is rebounding from yesterday’s modest declines which came about after API inventory data showed a modest build instead of the expected decline.  Gold (-0.4%) is under pressure along with most metals on the back of the dollar’s strength today.  In fact, my sense is the dollar is the driver right now.

So, speaking of the greenback, the only G10 currency to make a gain this morning is AUD (+0.15%) based on the higher yields Down Under.  Otherwise, the rest of the space is weaker between -0.2% and -0.5% with SEK the laggard.  In the EMG space, there is only one currency managing to hold its own, ZAR (+0.5%), which looks more like a trading bounce than a fundamental shift as there has been no data and no news yet on the political front regarding President Ramaphosa’s cabinet appointments.  Otherwise, the noteworthy move is that USDCNY has breached 7.30 for the first time since November as the pressure of higher US rates and an overall stronger dollar are too much to prevent continued weakness in the renminbi.

The only data this morning is New Home Sales (exp 640K) and the EIA oil inventories, which while important for the price of oil generally don’t have a macro impact otherwise.  As well, there are no Fed speakers on the calendar, but I cannot believe that at least one of them will want to hit the airways somehow.

So, the dollar has legs this morning and unless we get pushback that inflation is falling more clearly, I suspect that yields and the dollar will remain well bid.  It doesn’t feel like there is something that can change opinions due today.  Tomorrow and Friday, though, have that opportunity, so we shall see.

Good luck

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Will They Return?

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One-Sixty is so
Close, you can almost touch it
But, will they return?

 

The current Mr Yen, Masato Kanda, was on the tape last night as USDJPY creeps ever closer to the 160 level that triggered the most recent bout of inflation at the end of April. He explained, “If there are excessive currency fluctuations, it has a negative impact on the national economy.  In the event of excessive moves based on speculation, we are prepared to take appropriate action.”  At this point, the overnight high of 159.89 is just 28 pips from the peak seen prior to the last bout of intervention, although the price action this time is far more muted than what we saw then.  While the yen’s decline has been steady, as can be seen in the below chart, it hasn’t been so swift it appears out of control.

Source: tradingeconomics.com

One of the key rationales for the previous bout of intervention was that the weakening of the yen occurred too rapidly, with a 10-yen decline seen over a short six-week period.  That has not been the case this time, so I do not anticipate any MOF/BOJ action at 160, but rather somewhere closer to 165 if we see that during the summer.  Remember, the BOJ meets again at the end of July at which point they are expected to present their new bond buying program with reduced amounts of JGBs, their version of QT.  Remember, too, that there is still a huge interest rate differential between the US and Japan, and until that narrows, and is expected to narrow further, it is very difficult to see the yen showing any substantive strength.  While caution is merited here, as the BOJ can certainly enter the market at any time, based on the summary of opinions from the last BOJ meeting, which were released last night, there is no clear consensus on the pace of either QT or rate hikes.  The yen seems to have further to fall this summer.

In China, the powers that be
Are scared that their own renminbi
May fall and expose
The emperor’s clothes
Are missing, and that all might see

 

As things in the West are awaiting two key events at the end of the week, the PCE data in the US on Friday and the French elections on Sunday, we shall continue our look at Asia.  The CNY market onshore is frozen as it is pegged at the 2% maximum movement from the daily CFETS fixing.  Last night’s fixing of 7.1201 indicates that the highest the dollar can trade on shore is 7.2625, the level at which it is currently pegged.  In fact, given the interest rate differentials between the US and China, funding of traders’ books is becoming impossible because the one-day forward points will result in a price above the band.

While the offshore renminbi is slowly grinding lower, the pressure on the PBOC to adjust its daily fixing more rapidly grows.  This issue is a result of the following incompatible goals as defined by President Xi; support the collapsing local property markets by easing monetary policy while maintaining a stable and strong renminbi to demonstrate to the world that CNY should be a global currency (despite the capital controls in place!).  Alas for President Xi, these two ideas do not work in concert with the result that onshore FX markets are likely to remain frozen until things change.  A look at President Xi’s history tells me, at least, that like the Red Queen, he can believe multiple impossible things at the same time.  Ultimately, the great irony here is that despite Xi’s desires to demonstrate the importance of the renminbi to the world, he is entirely reliant on the Fed to cut rates in order to break this deadlock, and I strongly suspect that Chairman Powell cares not one whit about Xi Jinping and his problems.

Looking ahead, I anticipate the renminbi will grind lower over time as it remains the only outlet for the still lackluster growth in the economy with the property market problems forcing interest rates lower than otherwise would be desired.  Arguably, this is why the Chinese, in their current bout of trade talks with the EU, is demanding that Europe removes its tariffs on Chinese EVs.  Since they can’t weaken the currency further, they need to get the other side to effectively cut prices for them.

Ok, let’s review the overnight activity.  After Friday’s lackluster equity markets in the US (the NASDAQ actually fell, which I thought was illegal), the picture in Asia was mixed with the Nikkei (+0.5%) rallying a bit as the weak yen continues to support their exporters, while mainland Chinese shares (-0.5%) suffered as the ongoing weak economic data (Friday night showed Foreign direct investment fell -28.2% YTD, the weakest performance since 2009, and another indication that the renminbi is too strong).  As to the rest of the region, there were more laggards (Korea, Taiwan, Australia, New Zealand), than gainers (India, Singapore, Thailand).  However, in Europe this morning, the screens are all green as the limited data, German Ifo, indicated continued weakness raising hopes for a July rate cut by the ECB.  As to the US futures market, at this hour (7:15), they have edged slightly higher, about 0.15%.

Treasury yields have moved higher by 1bp but remain far closer to recent lows than the highs seen a month ago.  But the story in Europe is interesting as the Bund-OAT spread has narrowed by 5bps after comments by the RN party’s Jordan Bardella, the leading candidate as new PM, that were far more muted and accepting of Europe as a whole, and less populist financial goals.  This has played itself out across the entire continent with the perceived weaker countries seeing their yields slide slightly while Germany and the Netherlands have seen yields edge higher.  In Asia, JGB yields backed up 2bps to 0.98%, arguably in response to the summary statements from the BOJ.

Oil prices are continuing to show strength, up another 0.5% this morning, as the inventory draw from last week continues to support the market.  Meanwhile, after a very difficult session on Friday, metals prices are stabilizing with gold and silver both up 0.15%, although copper, which was higher earlier in the session, has now reversed course and is down -0.6%.

Lastly, the dollar is broadly, though not universally, under pressure this morning, with the euro (+0.35%) the driver in the G10 market which is also dragging the CE4 higher (PLN +0.9%, HUF +0.5%).  Bucking the trend is the rand (-1.0%) as market participants start to wonder who President Ramaphosa will be appointing to his cabinet now that he must share power.  One must be impressed with the volatility in the rand of late, that is for sure.

On the data front, while we get several indicators earlier in the week, all eyes will be on Friday’s PCE data.

TodayDallas Fed Manufacturing-13
TuesdayChicago Fed National Activity-0.4
 Case-Shiller Home Prices6.9%
 Consumer Confidence100.0
WednesdayNew Home Sales640K
ThursdayInitial Claims236K
 Continuing Claims1820K
 Durable Goods0.0%
 -ex Transports0.1%
 Q1 GDP (Final)1.3%
FridayPersonal Income0.4%
 Personal Spending0.3%
 PCE0.0% (2.6% Y/Y)
 Core PCE0.1% (2.6% Y/Y)
 Chicago PMI40.0
 Michigan Sentiment65.7

Source: tradingeconomics.com

As well as the data, we hear from five more Fed speakers with Governor Michelle Bowman speaking at three separate events this week.  However, thus far, there has been no substantive change from the Powell mantra that they need to see more evidence that inflation is slowing, several months’ worth, before considering easing policy.  Of course, if next week’s Unemployment rate were to tick up to 4.2%, I imagine that mantra might change.

On the central bank front, only Sweden’s Riksbank meets this week, and no policy change is expected.  If you recall last week, the bulk of the data was soft in the US, although the PMI data surprised to the high side.  However, if the data set is beginning to show more weakness, I suspect the Fed will begin to hint that cuts are possible sooner, rather than later.  Right now, the market is pricing about a 10% probability for the July meeting, but more than a two-thirds probability for September.  A little more weak data and I will likely adjust my views of rate cuts coming.  At that point, I think the dollar will suffer significantly.  But until we get a lot more evidence that is on the way, I think the default is the dollar is still the best bet.

Good luck

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Fearmongers Now Say

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A question that’s going around
Is where will the buyers be found
For all the new debt
That nations are set
To issue as budgets compound
 
As well, the fearmongers now say
A crisis is coming our way
If voters elect
The folks who reject
The status quo finance cliché

 

As markets return from yesterday’s US holiday, activity remains somewhere between muted and ordinary in most markets.  At times like these, it is interesting to take note of the tone of the articles in financial journals, whether the WSJ, Bloomberg or the New York Times, as they are the place where I find politics is inserted into the discussion.  

For instance, there have been several articles regarding the pending French election and the market’s concern about a victory by Marine Le Pen on the right.  The thesis seems to be if her RN party wins and takes over parliament, that her plans will result in a collapse in French finances based on the promises she has made throughout the campaign.  There are many analogies to what occurred in October 2022 in the UK, when the newly elected PM, Liz Truss, put forth a program of unfunded spending and the Gilt market fell sharply.  You may recall the result was that the BOE had to step in to buy Gilts even though at that time, they had just begun to sell them to reduce the size of their balance sheet. 

Of course, what gets far less press is the fact that UK insurance companies had levered up their balance sheets because of ZIRP as they tried to earn a sufficient return to match their pension liabilities and when the BOE started tightening policy, those companies were already in trouble.  Certainly, the market response accelerated the problem, but even without Truss, as the BOE kept raising rates, the outcome would likely have been the same.  However, it was politically expedient for the press to blame Truss and the Tories.

Now consider the US, where government profligacy is truly breathtaking as the current government is borrowing $1 trillion every 100 days or so.  Certainly, this topic has been reported, although it is difficult to find a discussion from the mainstream media that makes the leap that spending as much as is currently happening is the underlying cause.  (Yes, there are many stories of this from conservative media as well as on Twitter, but not on the CBS Nightly News.)  However, those same mainstream sources threaten everyone that in the event Donald Trump is elected, it will spell the end of the bond market and the US economy because of his policy proposals of tax cuts and supporting energy growth.

It is commentary of this nature that, in my opinion, has reduced the value of mainstream media via the constant politicization of every subject.  This is also why alternate media sources, like the numerous excellent articles on Substack, have become so popular and widely read.  Analysts who are not beholden to a corporate policy and politics are able to give much more accurate and politically unbiased views.

At any rate, there was much concern ahead of this morning’s French bond auctions (they issued €10.5 billion across various maturities from 3-8 years) as this was the first attempt to sell debt since President Macron called his snap election after his European Parliament electoral disaster.  However, happily for all involved (except the doom mongers) things went just fine with a solid bid-to-cover ratio and a modest decline in market spreads.  All told, while nobody knows the future, it is difficult to expect that a Le Pen government will be any worse financially than the current Macron led government.  After all, France has just been warned by the European Commission that it must reduce its budget deficit from the current 5.5% to 3.0% as per the Maastricht Treaty, and there is no “far-right” influence on the current government.

Enough politics, let’s recap the overnight markets.  Asian markets were mixed as the Nikkei edged higher (+0.15%) but the Hang Seng (-0.5%) gave back some of yesterday’s spectacular rally.  The laggard, though, was mainland China (-0.7%).  In Europe this morning, despite the fears of a Le Pen victory, the CAC (+1.0%) is the leading gainer as either we are seeing a trading bounce after a terrible week last week, or maybe the initial hysteria is being seen for what it was, unfounded hysteria.  Meanwhile, as the BOE just left rates on hold, as widely expected, the FTSE 100 has bounced about 0.3% in the first 15 minutes since the announcement and is up 0.5% on the day.  Overall, Europe is having a good day with the DAX and virtually all markets ahead.  US futures, too, are firmer this morning, with both the NASDAQ and S&P higher by 0.5% or more although the Dow continues to lag.

In the bond market, Treasury yields have backed up 2bps this morning but the picture in Europe is much more mixed.  German yields are higher by 3bps, but UK yields have slipped a similar amount.  In fact, looking at all the nations there, it appears that there is slightly less concern over Europe as a whole as French yields are only higher by 1bp and Italian yields have slipped 1bp, thus narrowing the spread with Germany overall.  Turning to Asia, JGB yields rose 2bps, following USDJPY higher, or perhaps anticipating a higher inflation reading tonight.

In the commodity markets, crude oil (+0.15%) is edging higher this morning, although it slipped in futures trading yesterday (the only market open).  This morning brings the inventory data which is anticipating a draw of 2M barrels.  Metals markets are solid again with gold (+0.4%), silver (+1.7
%) and copper (+0.2%) all continuing their rebound from the dramatic decline two weeks ago.

Finally, the dollar is stronger this morning against most of its counterparts, notably the JPY (-0.3%) and CNY (-0.1%).  I highlight these because the yen story remains critical to the global financial markets, and it appears that Japanese investors are beginning to turn back toward Treasuries and away from JGBs supporting the moves in those markets and USDJPY.  

Regarding China, last night the PBOC fixing was at 7.1192, its highest level since November 2023 and the largest move (33 pips) in weeks.  It appears that there are numerous changes being considered and ongoing in China regarding its domestic bond market (the PBOC is looking to become more involved to support liquidity) as well as the overall monetary structure (there is talk that they will be adjusting the framework of three different rates to something more akin to what Western central banks use with a single policy rate).  In the end, given the ongoing lackluster performance of the Chinese economy, a weaker CNY remains my base case and while it may be gradual, it seems it is the PBOC’s view as well.  The onshore market continues to trade at the edge of the 2% allowable band and the offshore market is a further 35bps higher (weaker CNY) than that.  

Elsewhere, ZAR (-0.85%) which has had a good run on the back of the ultimate electoral outcome, seems to be afflicted with some profit-taking and then most of the rest of the currencies are softer vs. the dollar by about 0.2%.  One last exception is CHF (-0.65%) which has slipped after the SNB cut their policy rate by 25bps, as expected, to 1.25%.

On the data calendar today, we see Initial (exp 235K) and Continuing (1810K) Claims, Philly Fed (5.0), Housing Starts (1.37M) and Building Permits (1.45M), all at 8:30.  Then, later this afternoon, Thomas Barkin of the Richmond Fed will undoubtedly remind us that things are moving in the right direction, but patience is required.

Summing it all up, while I didn’t specifically mention it, the key thing in financial markets continues to be Nvidia, which is much higher in pre-market trading again, and apparently is the driver of everything.  However, traditional relationships have been under strain as although it appears to be a risk-on day, both the dollar and precious metals are firmer.  Overall, nothing has changed my view that the Fed is going to remain firm for now, and that (too) much credence will be assigned to next Friday’s PCE data.  But such is the state of the world.

Good luck

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Ain’t

Posted on by

Ueda explained
Buying bonds is still our bag
But buying yen ain’t

 

The last of the major central banks met last night as the BOJ held their policy meeting.  As expected, they left the policy rate unchanged between 0.00% and 0.10%.  However, based on the April meeting comments, as well as a “leak” in the Nikkei news, the market was also anticipating guidance on the BOJ’s efforts to begin reducing its balance sheet.  Remember, they still buy a lot of JGBs every month, so as part of the overall normalization process, expectations were high they would indicate how much they would be reducing that quantity.

Oops!  Here is their statement on their continuing QQE program [emphasis added]:

Regarding purchases of Japanese government bonds (JGBs), CP, and corporate bonds for the intermeeting period, the Bank will conduct the purchases in accordance with the decisions made at the March 2024 MPM. The Bank decided, by an 8-1 majority vote, that it would reduce its purchase amount of JGBs thereafter to ensure that long-term interest rates would be formed more freely in financial markets. It will collect views from market participants and, at the next MPM, will decide on a detailed plan for the reduction of its purchase amount during the next one to two years or so. 

In other words, they have delayed the onset of their version of QT by another month and based on the nature of their process, where they pre-announce the bond buying schedule on a quarterly basis, it is entirely possible that the delay could be a bit longer.  You will not be surprised to know the yen fell sharply on the news, as per the below chart.

Source: tradingeconomics.com

In fact, it traded to its weakest (dollar’s highest) level since just prior to the intervention events in April.  However, as you can also see, that move was reversed during the press conference as it became clear to Ueda-san that his delay did not result in a desired outcome.  The issue was the belief that the BOJ cannot make decisions on interest rates and QT simultaneously (although for the life of me, I cannot figure out why that was the belief), and so Ueda addressed it directly, “We will present a concrete plan for long-term JGB buying operations in July. Of course, it’s possible for us to raise the short-term interest rate and adjust the degree of monetary easing at the same time depending on the information available then on the economy and prices.”

In the end, the only beneficiary of this was the Japanese stock market, which managed a modest rally of 0.25%.  Certainly, this did not help either Ueda’s or the BOJ’s credibility that they are prepared to normalize policy, and it also left the entirety of currency policy in the lap of the MOF.  The problem for Ueda-san is that until the Fed decides it is time to start cutting interest rates, a prospect which seems further and further distant, the yen is very likely to remain under pressure.  I am beginning to suspect that despite Ueda’s stated goal of normalizing monetary policy, the reality is that, just like every other central banker today, his bias is toward dovishness, and he cannot let go.  I fear the risk is that the yen could weaken further from here rather than it will strengthen dramatically, at least until there are real policy changes.  FYI, JGB yields closed 3bps lower after the drama.

Away from that, the overnight session informed us that Chinese economic activity appears to be slowing, at least based on their loan growth, or lack thereof.  Loans fell, as did the pace of M2 Money Supply and Vehicle Sales.  While none of these are typically seen as major data releases, when combined, it seems to point to slowing domestic activity.  The upshot is a growing belief that the PBOC will ease policy further thus supporting Chinese equities (+0.45%) and maintaining pressure on the renminbi which continues to trade at the limit of its 2% band vs. the daily CFETS fixing.

As to Europe, it is becoming clearer by the day that investors around the world have begun to grow concerned over what the future of Europe is going to look like.  Despite the ECB having cut their interest rates last week, the results of the European Parliament elections continue to be the hot topic and we are seeing European equity markets slide across the board, with France (-2.5% today, -5.8% this week) leading the way lower as President Macron’s Renaissance Party looks set to be decimated in the snap elections at the end of the month.  But the entire continent is under pressure with Italy (-2.8% today, -5.7% this week) showing similar losses and the other major nations coming in only slightly better (Germany -2.75% this week, Spain -3.9% this week).  You will not be surprised to know that the euro (-0.4%) is also under pressure this morning, extending its losses to -1.0% this week with thoughts it can now test the lows seen last October.

There is a great irony that the G7 is meeting this week as so many of the leaders there, Italy’s Giorgia Meloni and Japan’s Kishida-san excepted, looks highly likely to be out of office within a year.  Macron, Olaf Sholz, Justin Trudeau, President Biden and Rishi Sunak are all far behind in the polls.  One theory is that the blowback from the draconian policies put in place during the pandemic restricting freedom of movement and speech within these nations, as well as the ongoing immigration crisis, which is just as acute in Europe and the UK as it is in the US, has turned the tide on the belief that globalization is the best way forward.  

Earlier this year I forecast that there would be very severe repercussions during the multitude of elections that have already taken place and are yet to come.  Certainly, nothing has occurred that has changed that opinion, and in fact, I have a feeling the changes are going to be larger than I thought.  

The reason this matters is made clear by today’s market price action.  If the world is turning away from globalization, with a corresponding reduction in trade, equity markets which have been a huge beneficiary of this process (or at least large companies have directly) are very likely to come under further pressure.  As well, fiscal policies are going to put more pressure on central banks as the natural response of politicians is to spend more money when times are tough, and we could see some major realignments in market behaviors.   This will lead to ongoing inflationary pressures, thus weaker bond prices and higher yields, weaker equity prices, much strong commodity prices and the dollar, ironically, likely to do well as it retains its haven status.  Certainly, the euro is going to be under pressure, but very likely so will many other currencies.  This is a medium to long-term concept, certainly not something that is going to play out day-to-day right now, but I remain firmly in the camp that many changes are coming.

As to the rest of the markets overnight, yields are falling everywhere (Treasuries -5bps, Gilts -9bps, Bunds -12bps, OATs -6bps, Italian BTPs -1bp) as investors are seeking havens and for now, bonds seem better than stocks.  You will also notice that the spread between Bunds and other European sovereigns is widening as there is clear discernment about individual nation risk.  This is not a sign that everything is well.

Maintaining the risk-off thesis, gold (+1.25%) and silver (+1.00%) are rallying despite a much stronger dollar this morning and we are also seeing some strength in oil (+0.2%).

As to the dollar, it is stronger vs. almost every one of its counterparts this morning, most by 0.3% or more with CE4 currencies really under pressure (PLN -1.0%, HUF -0.8%).  However, there are two currencies that are bucking this trend, CHF (+0.25%) which is showing its haven characteristics and ZAR (+0.5%) where the market is responding to the news that the ANC has put together a coalition and that President Ramaphosa is going to remain in office.

Yesterday’s PPI data showed softness similar to the CPI on Wednesday but more surprisingly, the Initial Claims number jumped to 242K, its highest print since August 12, 2023, and a big surprise to one and all.  The combination of data certainly added to yesterday’s feel that growth and inflation were ebbing.  This morning, we get the Michigan Sentiment (exp 72.0) and then a couple of Fed speakers (Goolsbee and Cook) later on during the day.

I should note that equity futures are all in the red this morning, with the Dow continuing to lag the other markets, probably not a great signal of future strength.  Arguably, part of today’s price movement is some profit taking given US equity markets have rallied this week and month.  But do not discount the bigger issues discussed above as I believe they will be with us for quite a while to come and put increasing pressure on risk assets with support for havens.  As such, I think you have to like the dollar given both the geopolitical issues and the positive carry.

Good luck and good weekend

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Not Soaring

Posted on by

It seems that prices
In Japan are not soaring
Like the hawks would want

 

Japanese inflation data last night showed a continued decline as the Core rate fell to 2.2%, and the so-called super core rate slipped to 2.4%, its lowest level since October 2022.  As you can see in the super core chart below, the trend seems clearly to be downward although the current level remains far above inflation rates for most of the past 30 years.

Source: tradingeconomics.com

The irony here is that were this the chart of the inflation rate in any other G7 nation, the central bank would be crowing about how successful they had been at slaying the inflation dragon.  Alas, as the chart demonstrates, Japan’s dragon was a different species, and one that I’m pretty sure the 122 odd million people there were very comfortable having as a “pet”.  After all, I have never met a consumer who was seeking prices to rise before they bought something, have you?

From a market perspective, the continued decline in inflation rates calls into question just how much further Japanese interest rates need to rise in order to achieve the BOJ’s goals.  Again, remember the BOJ’s goals for the past decade has been to RAISE the inflation rate to 2% and their tactic has been to create the largest QE program in the world such that they now own more than 50% of the outstanding Japanese government debt across all maturities.  If inflation continues to decline back to, and below, 2%, while I’m confident the general population there will have no objections, Ueda-san may find himself in a difficult position.  

Arguably, if higher inflation is the goal (and politically that seems nuts) then the most effective tool the nation has is to allow the yen to continue to weaken and import inflation.  I continue to believe that this will be the process going forward, and while very sharp and quick declines will be addressed, a slow erosion will be just fine.  Absent a major change in US monetary policy to something much easier, I still don’t see a case for a much stronger yen.  However, as a hedger, I would continue to consider options to manage the risk of any further bouts of intervention.

While many are still of the view
That rate cuts are long overdue
What yesterday showed
Is growth hasn’t slowed
So, Jay and his friends won’t come through

Back home in the US, yesterday’s data releases did nothing to encourage the large contingent of people who are desperate looking for a rate cut before too long.  While New Home Sales were certainly lousy, falling from the previous month’s downwardly revised level, and the Chicago Fed’s National Activity Index was also quite soft, indicating economic activity had slowed last month, the Flash PMI data got all the attention with both Manufacturing (50.9) and Services (54.8) rising sharply, an indicator that there is still life in the economy yet.  The result was that we saw US yields rise (10yr +7bps), the dollar strengthen, and equity markets give back their early, Nvidia inspired, gains to close lower on the day.  While equity futures are rebounding slightly this morning, confidence that a rate cut is coming soon has clearly been shaken.

Adding to the gloom was a reiteration by Atlanta Fed president Bostic that it is going to take a lot longer for rates to impact inflation than in the past.  In a discussion with Stanford Business School students, he focused on the fact that so many people locked in low mortgage rates during the pandemic and recognized, “the sensitivity to our policy rate — the constraint and the degree of constraint that we’re going to put on is going to be a lot less.” For those reasons, Bostic said, “I would expect this to last a lot longer than you might expect.”  This discussion has been gaining more adherents as the punditry is grudgingly beginning to understand that their previous models are not necessarily relevant given all the changes the pandemic wrought.  Summing up, there continues to be no indication, especially in the wake of the more hawkish tone of the Minutes on Wednesday, that the Fed is going to cut rates soon.

So, with the new slightly less perfect world now coming into view, let’s take a look at market behavior overnight.  Yesterday’s US equity slide was continued everywhere else around the globe with Asian markets (Nikkei -1.2%, Hang Seng -1.4%, CSI 300 -1.1%) under uniform pressure and European bourses, this morning, also in the red, but by a lesser -0.4% or so across the board.  For many of these markets (China excepted) they have recently run to all-time highs, or at least very long-term highs, so it should be no surprise that there is some consolidation.  There is a G7 FinMin meeting this weekend and the comments we have heard so far indicate that the ECB is on track to cut rates next month, but there are no promises for further cuts.  Net, it seems clear that as much as most central banks want to cut interest rates, they are still terrified that inflation will return and then they have an even bigger problem.

In the bond market, it has been a very quiet session after yesterday’s yield rally with Treasury yields unchanged this morning and European sovereign yields similarly unmoved.  Even JGB yields are flat on the day as it appears bond traders and investors started their long weekend a day early.  Remember, not only Is Monday a US holiday, but it is a UK holiday as well, so there will be very little activity then.

In the commodity markets, oil prices remain under pressure and are drifting back toward the low end of their recent trading range.  One story I saw was that there is a renewed effort to get the ceasefire talks in Gaza back on track, but that seems tenuous at best.  Given the strength seen in the PMI data across Europe and the US, it would seem the demand side of the story would improve things here, but not yet.  As to the metals markets, after a serious two-day correction, this morning is bringing a respite with both gold and silver prices bouncing while copper prices remain unchanged.  I remain of the view that the longer-term picture for metals is still intact, so day-to-day trading activity should be taken with a grain of salt.  Ultimately, I continue to believe that the central banking community is going to cut rates before inflation is controlled and that will lead to much bigger problems going forward along with much higher commodity prices.

Finally, the dollar, which rallied alongside yields yesterday, is giving back some of those gains, albeit not very many of them.  The commodity currencies (AUD +0.2%, NZD +0.2%, ZAR +0.4%, NOK +0.6%) are the leading gainers this morning although the euro is also firmer as is the pound despite much weaker than expected UK Retail Sales data.  Alas, the poor yen can find no support and continues to drift a bit lower, with the dollar back above 157 this morning and keep an eye on CNY, which is now back above 7.25 for the first time in a month after Chinese FDI data showed larger than expected -27.9% decline.  It seems that President Xi has successfully scared off most foreign investment which is very likely a long-term problem for the nation.  While it has been very gradual, the fixing rate continues to weaken each day as it appears the PBOC is finally accepting the need for a weaker yuan.

On the data front, we see Durable Goods (exp -0.8%, +0.1% ex-Transports) and then Michigan Confidence (67.5) which continues to be a problem for President Biden’s reelection campaign as the people in this country are just not happy.  We also hear from Governor Waller this morning.  It will be very interesting to hear him as my anecdotal take is that the regional presidents have been much more hawkish than the governors and Chairman Powell, so if he leans dovish, it may demonstrate a bigger split between factions on the board than we have been led to believe.  We shall see.

Net, it remains very difficult for me to make a case for the dollar to weaken substantially at this time.  While it may not power ahead, a decline seems unlikely for as long as higher for longer remains the mantra.

Good luck and good long weekend

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There will be no poetry on Monday due to the holiday.

Losing His Doubt

Posted on by 
The jury is no longer out
And Jay may be losing his doubt
That ‘flation is slowing
So, bulls are now crowing
Let’s end, soon, this rate-cutting drought!

I am old enough to remember when Chairman Powell explained that he did not have confidence inflation was falling back to the target level and so maintaining the current, somewhat restrictive, policy stance would be appropriate for longer than had been originally anticipated.  In other words, higher for longer was still the operating thesis.  That is soooo two days ago!  Apparently, when CPI prints at 0.3% M/M for both headline and core with the Y/Y readings at 3.4% and 3.6% respectively, that means the inflation fight is won.  Now, I will grant that the headline monthly number was 0.1% below expectations, but everything else was right on the money.  On the surface, it is not clear to me that this signaled the all-clear for the end of inflation.  As my good friend Mike Ashton (@inflation_guy) said in his write-up yesterday, “the sticky stuff is not yet unstuck.”  But the market saw this news and combined with a clearly weaker than expected Retail Sales print (0.0%) and weaker than expected Empire State Manufacturing print (-15.6) and was off to the races.

So, risk is back in vogue and bond yields are tumbling.  Hooray!  This is the perfect encapsulation of how the actual data may not mean very much per se, but the framework of how investors and traders were positioned and anticipating the data is the key driving force.  So, not only did equity markets in the US rally 1% or more, but Treasury yields fell 10bps in the 10yr and 8bps in the 2yr.  Meanwhile, September is now the odds-on favorite for the first interest rate cut, politics be damned.

At this point, the question becomes will the Fed respond to this small sample of data in the same way the market has?  The first comments from Fed speakers seemed more circumspect than the market opinions.  Chicago Fed president Goolsbee, who was not on the calendar, said the following in an interview, “[inflation showed] some improvement from last time, pretty much what we expected, but still higher than we were running for the second half of last year, so there’s still room for improvement.”  Meanwhile, Minneapolis Fed president Kashkari explained, “The biggest uncertainty in my mind is how much downward pressure is monetary policy putting on the economy? That’s an unknown. And that tells me we probably need to sit here for a while longer until we figure out where underlying inflation is headed before we jump to any conclusions.”

To my eye, there is no indication that the Fed has changed their tune, at least not yet.  If we continue to see data that indicates the long-awaited recession is actually closing in, I expect that we will begin to hear more of a consensus view regarding the initial rate cuts other than the current higher for longer stance.  Of course, if a recession is making an appearance, my sense is that will not be a huge benefit for risk assets either, but what do I know, I’m just a poet. Ok, I don’t think we need to spend any more time on that subject for today so let’s see what is happening elsewhere. 

In Japan, the economic news remains less positive than the Kishida administration would like to see.  Last night, Q1 GDP was released at a worse than expected -0.5%, its second negative print in the past three quarters with Q4 a ‘robust’ 0.0% in between.  While not technically a recession, the situation there certainly does not have a positive feel.  Making things even worse, of course, is the fact that inflation remains higher than their target of 2%, although it has been slowly drifting lower over the past year. 

The interesting thing about this situation is that the BOJ does not have a dual mandate regarding prices and employment; but is focused only on price stability.  However, if economic activity continues to slow there, can Ueda-san really tighten policy further?  And what of the yen?  It has drifted higher (dollar lower) alongside the dollar’s broad down move on the back of the recent decline in US yields.  However, it feels to me like Ueda’s path to tighter policy just got a lot narrower if economic activity in Japan is going to remain so lackluster.  Many pundits have decided that the yen’s weakness reached its peak ahead of the recent bout of intervention two weeks ago.  I am not so sure.  Absent a significant slowdown in the US, I’m sensing that the policy divergence may even widen going forward, not narrow, and the yen would not respond well to that outcome.

With all that in mind, let’s survey the overnight session to see what else is happening.  Asian equity markets followed the US rally with solid gains across the board.  Clearly, the prospect of lower US rates was seen as a positive.  However, the same is not true in Europe, where bourses are all lower this morning albeit not dramatically so.  Declines of between -0.25% and -0.5% are universal.  My take is that this is a bout of profit-taking as to much less fanfare than US markets, many European bourses have just touched all-time high levels, so a little pullback should be no surprise.  This is especially true given there was neither data nor commentary that would indicate something in Europe has changed.  The situation remains slow growth, slowing inflation and rate cuts next month.  Lastly, US futures are essentially unchanged at this hour (6:45) as traders await more data and, perhaps more importantly, 4 more Fed speakers.  I think the trading community is looking for Fed confirmation of their response to the CPI data yesterday which, as mentioned above, was not forthcoming.

Bond markets, which all rallied yesterday following the Treasury move, are little changed this morning with virtually no movement in the US or Europe.  Overnight, JGB yields slipped 3bps in the wake of the US data, but this market is entirely focused on the US economy and the Treasury marker for its lead.

In the commodity markets, oil is a touch softer this morning, but remains firmly toward the middle of its recent trading range as conflicting reports regarding expected demand continue to confuse practitioners.  FWIW any report that indicates demand for oil is going to decrease makes no sense to me given how many people on this earth are energy poor and will do as much as they can to get hold of energy.  But that’s just my view.  The IEA continues to forecast reductions in demand because they are desperately pushing their transition thesis because their models are old and unreliable.  As to metals markets, yesterday saw a major rally in gold and silver, with the latter making a push for $30/oz for the first time since 2013.  Copper, however, may have seen a blow-off top yesterday as it has fallen back sharply from its peak and is now back below $5.00/lb.  In truth, the demand story here remains attractive, but the price action did seem to get out of hand there.

Finally, the dollar, which sold off hard yesterday on the CPI and Retail Sales news is bouncing slightly this morning.  Those sharply lower yields in the US, even though they were matched by Europe, were a signal to sell dollars across the board.  Thus, this morning’s 0.2% ish bounce should not be that surprising.  It is in this segment of the market that I believe the opportunity for the biggest structural changes exist.  After all, the dollar’s strength over the past 3 ½ years has been built on the Fed being the most hawkish central bank around as they belatedly fought inflation.  While they have made clear they want to start to cut interest rates, the data has not been supportive of that move.  If yesterday’s data is the beginning of a more consistent slowdown in the US, those rate cuts may be coming sooner than currently priced and regardless of what happens to risk assets, the dollar would suffer.  We shall see.

On the calendar today we have a bunch more data and four more Fed speakers (Barr, Harker, Mester and Bostic).  The data brings the weekly Initial (exp 220K) and Continuing (1780K) Claims, Housing Starts (1.42M), Building Permits (1.48M) and Philly Fed (8.0) all at 8:30 then IP (0.1%) and Capacity Utilization (78.4%) at 9:15.  As Chairman Powell has repeatedly explained, he and his colleagues look at the totality of the data, so another wave of soft numbers here would likely get risk asset markets excited.  However, listening to what they have all continued to say informs me that the Fed is not nearly ready to cut rates.  September remains the odds-on favorite for the first cut, but I still suspect that they could be here all year long.  If I am right about that, the dollar will retain its bid overall.

Good luck

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Less Stout

Posted on by 
Suzuki-san and
Ueda-san are clearly
Flocking together

Events continue to unfold in Japan that appear to point to a more concerted effort to address the still weakening yen.  The problem, thus far, is that it hasn’t yet really worked, absent the direct intervention we saw at the beginning of the month.  For instance, last night, 10-yr JGB yields rose to their highest level since June 2012, trading up to 0.969% and finally looking like they are going to breech that 1.00% level that had so much focus back in October.  At the same time, the two key players in this drama, FinMin Suzuki and BOJ Governor Ueda are actively speaking to each other as they try to coordinate policy.  The problem for Suzuki-san is that Q1 GDP fell back into negative territory again, thus bringing two of the past three quarters down below zero.  While that is not the technical definition of a recession, it certainly doesn’t look very good.

And yet, the yen remains under pressure, slipping another 0.1% last night, and as can be seen from the chart below, continuing its steady decline (dollar rise) from the levels seen immediately in the wake of the intervention.

Source: tradingeconomics.com

Another interesting thing is that our esteemed Treasury Secretary, Janet Yellen, seems to be concerned over any intervention carried out by the Japanese, at least based on comments she recently made in a Bloomberg interview, “It’s possible for countries to intervene.  It doesn’t always work without more fundamental changes in policy, but we believe that it should happen very rarely and be communicated to trade partners if it does.” 

There have been several analysts of late who have made the case that Yellen’s trip to Asia last month included a ‘secret’ Plaza Accord II type arrangement, where there was widespread agreement that the dollar needed to come down in value.  First off, secrets like that are extremely difficult to keep secret, and history shows that doesn’t happen very frequently.  But more importantly, based on the fact that inflation is one of the biggest problems that her boss has leading up to the election, a weaker dollar is the last thing she would want.  I suspect if we continue to see the yen decline, the BOJ/MOF will be back at the intervention game again, but the US will not be helping.  Keep in mind, though, Japanese yields.  If the BOJ is truly going to allow yields to rise in Japan, that would have a significant impact on the yen’s value in the FX markets.  While 1.00% is a big round number, I think we will need to see the BOJ demonstrate a more aggressive stance overall…or we need to see the data turn softer in the US to allow the Fed to get on with their much-desired rate cuts.  We will need to watch this closely going forward.

While everyone’s waiting to see
How high CPI just might be
One cannot rule out
An outcome less stout
Where bond and stock bulls are set free

Which brings us to the inflation story.  By this time, everyone is aware that tomorrow’s CPI data is seen as a critical piece of the puzzle.  I continue to read coherent arguments on both sides of the debate regarding the trend going forward.  (Let’s face it, the error bars are far too wide to be confident in a specific forecast.)  For the inflationistas, they continue to look at things like the housing market, which while frequently expected to see declining price pressures, has maintained an upward trend for the past several years.  As well, things like the dramatic rise in certain commodity prices (coffee comes to mind) and the substantial rise in the price of insurance (something of which I speak from personal experience!), there is ample evidence that prices continue to climb. 

Part of this puzzle may be the result of the fact that companies continue to successfully raise prices, or at least had been doing so for the past two years, as evidenced by the continued strong earnings, and more importantly, still high gross margins they are able to achieve.  So, as input prices have risen, they have passed those costs along to the consumer quite successfully.  Now, the comments from Starbucks and McDonalds at their earnings reports indicating business is slowing down and attributing that slowdown to rising prices may well be a harbinger that companies have lost the ability to keep this up.  But two companies, even large ones, are not nearly the whole economy.  As well, much has been made, lately, of the K-shaped economy, where the haves continue to benefit from the rise in asset prices and are far less impacted by rising prices as they can afford them.  This has led to continued strong demand for luxury goods, which while a smaller sector of the economy, remain highly visible. Meanwhile, the less fortunate lower 90% of the population find themselves struggling to make ends meet as real wages remain stagnant and there continues to be a switch from full-time to part-time employment ongoing as companies adjust their staffing needs.  PS, those part time jobs don’t pay as well and generally don’t have benefits, so any price increases are very tough to swallow.  In the end, it appears that housing, insurance services and food remain in upward price trends.

On the flipside, there are many who see that while Q1’s inflation data was sticky on the high side, things should begin to improve going forward.  They point to things like M2, which has fallen dramatically over the past two years, although has recently inflected higher again.  However, the argument is that the lag between the movement in M2 and inflation is somewhere in the 16-24-month period, and we are now due to see prices decline.  In addition, they point to things like loan impairments and credit card delinquencies rising as signs that companies have lost their pricing power and prices will reflect that by slowing their ascent.

Now, today we see the PPI, which may give clues as to tomorrow’s outcome and the following are the median expectations:  headline 0.3% M/M, 2.2% Y/Y; core 0.2% M/M, 2.4% Y/Y.  Looking at the chart, it certainly appears that this statistic has bottomed out just like CPI.

Source: tradingeconomics.com

But here’s the thing…I have a feeling that regardless of the outcome, the market is going to rally in both stocks and bonds.  Certainly, if it is a softer than forecast number, the rate cut narrative is going to be going gangbusters and stocks will rocket while yields fall.  If it is on the money, my sense is the market is still in the camp that despite what we continue to hear, especially with Powell having removed the possibility of a rate hike, that the view will turn to rate cuts are coming as the Fed’s underlying dovishness will prevail.  But if the numbers are hot, while the initial reaction will almost certainly be a decline in risk asset prices, I have a feeling it will be short-lived.  Positioning is not overly long here, at least according to the fear/greed indicators, and the theme that the administration will do all it can to get re-elected, meaning lots more fiscal support, is going to work in favor of risk assets.  One other thing, if there is some trouble in the bond market, the one thing we know for sure is that Powell will come to the rescue and support the whole structure.

Net, while the timing of each outcome may differ, I sense the end result will be the same.  As to the dollar, I remain in the camp that international investors will continue to buy dollars to buy the S&P.  As well, given it seems very clear that both the ECB and BOE are going to cut rates in June while the Fed remains a much lower probability to do so, that should prevent any sharp dollar decline, although it may not push it any higher.

Overnight, basically nothing happened as everybody is holding their collective breath for tomorrow.  Maybe today will be a harbinger, but I expect a generally slow session overall absent a HUGE surprise in PPI.

Good luck

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Towards the Stars

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As the yen declines
Pressure on the BOJ
Climbs up towards the stars

 

Intervention in the currency markets has a long and undistinguished history.  At least that is true for nations that have open capital accounts.  In fact, a key reason that countries impose and maintain capital account restrictions is to avoid the situation of having their currency collapse when the locals fear future loss of purchasing power, i.e. inflation is rising. While there have been situations where a central bank has been able to prevent a significant movement in the past, it has almost always been in an effort to prevent too much currency strength, never weakness.  

A great example is Switzerland in January 2015.  As you can see from the chart below of the EURCHF cross, Switzerland was explicitly targeting a level, 1.20, in the cross as the strongest the Swiss franc could trade (lower numbers indicate a stronger CHF).  This was in an effort to support the export sectors of the economy during a period shortly after the Eurozone crisis when Europeans were quite keen to convert their funds to Swiss francs as a more effective store of value.  

Source: tradingeconommics.com

The upshot was that the Swiss National Bank wound up effectively printing and selling hundreds of billions of francs, receiving dollars and euros and then investing those proceeds into the US stock market.  At one point, they were the largest shareholder in Apple!  But even in this case, where you would expect a nation could prevent their currency from rising too far or too fast, the process overwhelmed the SNB and one day in January 2015 they simply said, enough.  That 25% appreciation in the franc took about 15 minutes to accomplish and as evidenced by today’s exchange rate of 0.9768, it has never been unwound.

And that’s what happened to a central bank that is trying to prevent its own currency from strengthening.  For central banks to prevent weakness is an entirely different story and a MUCH harder task.  As I have repeatedly explained, the only way to change the trajectory of a currency is to alter monetary policy.  At this time, given the Fed’s commitment to higher for even longer, the only way Japan can prevent more substantial yen weakness is for the BOJ to tighten policy even further.  This is made evident in the below chart of the price action in USDJPY for the past month.  In it, you can see when it spiked above 160 on April 28th, and the subsequent intervention that day and then two days later.  

Source: tradingeconomics.com

However, in both cases, despite spending upwards of $60 billion intervening, the yen immediately resumed its downtrend (dollar uptrend) and this morning it is back above 155.  It is this price action that appears to have finally awoken Ueda-san as last night, in an appearance at the Japanese parliament, he explained the following, “Foreign exchange rates make a significant impact on the economy and inflation.  Depending on those moves, a monetary policy response might be needed.”  Ya think!  Ueda-san was followed in parliament by FinMin Suzuki who repeated something he said last week, “Since Japan relies on overseas markets for food and energy, and a large portion of its transactions are denominated in dollars, a weaker yen could raise prices of imported goods.”  While those comments are self-evident, the fact that he needed to repeat them is indicative of the idea that Japan is getting increasingly uncomfortable with the current yen exchange rate.

So, will Ueda-san raise rates at the next meeting in June?  Will he alter their QQE policy and explicitly explain they will no longer be buying JGBs?  Certainly, the market is on edge right now given the two bouts of intervention from last week, but not so on edge that it isn’t continuing to sell the currency and capture the carry.  At this point, you cannot rule out a third wave of intervention, and certainly we should expect more jawboning.  But in the end, if they are serious about the yen being too weak, Ueda-san will have to move.  At this point, I am not convinced, but the meeting is on June 14th, so there is plenty of time for things to become clearer.

And other than that, quite frankly, not much is going on.  So, let’s take a tour of markets to see how things stand this morning.

Yesterday’s equity markets in the US were tantamount to being unchanged across the board, at least that is true of the major indices.  There were certainly individual equities that moved.  In Asia, it was a mixed picture with both Japanese (Nikkei -1.6%) and Chinese (CSI 300 -0.8%) shares in the red, which dragged down HK shares.  But elsewhere in the region, we saw more gains than losses, albeit none of the movement was that large overall.  Meanwhile, in Europe, all the markets are looking robust this morning with gains ranging from 0.5% (DAX, FTSE 100) to 1.0% (CAC) and everywhere in between.  The Swedish Riksbank cut rates by 25bps, as anticipated this morning, and perhaps that has encouraged investors to believe the ECB is going to embark on a more significant easing campaign starting next month.  Certainly, the limited data we saw this morning, (German IP -0.4%, Spanish IP -1.2%, Italian Retail Sales 0.0%) are not indicative of an economy that is growing strongly.  Finally, US futures are just a touch lower, -0.2%, at this hour (7:15).

Despite the weakness in Eurozone data, and the absence of US data, yields are rebounding a bit this morning with Treasuries higher by 3bps and the entire European sovereign spectrum seeing yields rise by 3bps to 4bps.  It seems unlikely that the weak Eurozone data is the driver and I suspect that this movement is more a trading reaction based on the recent decline in yields.  After all, just one week ago, yields were more than 20 basis points higher, so a little rebound can be no surprise.

In the commodity markets, oil (-1.1%) is under pressure as rising inventories outweigh ongoing concerns over Israel’s Rafah initiative.  While the EIA data is generally considered the most important, yesterday’s API data showed a build of more than 500K barrels vs. expectations of a 1.4M barrel draw.  At the end of the day, this is still a supply/demand driven price, and if supply is more ample, prices will fall.  In the metals markets, precious metals continue to trade choppily around recent levels, but we are starting to see some weakness in the industrial space with both copper (-1.25%) and aluminum (-1.6%) under pressure this morning.  Certainly, if economic activity is starting to wane, these metals are likely to suffer.

Finally, in the FX markets, the dollar is continuing to rebound from its recent selloff, gaining against virtually all its counterparts, both EMG and G10.  SEK (-0.5%) is the biggest mover in the G10 after the rate cut, but JPY (-0.45%) is not far behind.  We are also seeing weakness in AUD (-0.4%) on the back of those metal declines.  As to the EMG bloc, ZAR (-0.7%) is the laggard there, also on the metals weakness, but we saw KRW (-0.5%) suffer overnight as well amidst the general dollar strength.

Once again, there is no US data on the calendar although we hear from three more Fed speakers, Boston’s Collins as well as governor’s Cook and Jefferson.  Yesterday, Mr Kashkari did not give us any new information, indicating that higher for longer still makes the most sense and even questioning the level of the neutral rate, implying it may be higher than previously thought.  But there have been no cracks in the current story that the Fed is not going to alter policy soon.

While day-to-day movements remain subject to many vagaries, the reality is that the trend in the dollar has been higher all year and as long as monetary policies around the world remain as currently priced, with the Fed the most hawkish of all, the dollar should grind higher over time.

Good luck

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