Tag Archives: #JPY

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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Unfair-ish

Posted on by

Well, Jay and the doves got their wish
As CPI data went squish
In fact, it’s not clear
Why cuts aren’t here
Already, it’s just unfair-ish
 
But something surprising occurred
‘Cause rallies in stocks weren’t spurred
But yields and the buck
Got hit by a truck
While gold was both shaken and stirred
 
Chairman Powell must be doing his happy dance this morning as the CPI data was the softest seen since May 2020 during the height of the Covid shutdowns.  Now, after four years of steadily rising prices, the Fed is undoubtedly feeling better.  One look at the chart below, though, shows that the inflation rate since the end of Covid was clearly much higher than that to which the population became accustomed prior to Covid.

 

Source: tradingeconomics.com

While the annualized data for both core and headline readings remains above 3.0%, there was certainly good news in that shelter and rental costs rose more slowly than they have in nearly three years.  However, for market participants, they are far less concerned over the whys of the soft reading than in the fact that the reading was soft and so they can now anticipate a rate cut even sooner than before.  As of this morning, the Fed funds futures market is now pricing a 92.5% probability that the Fed cuts in September and a total of 61bpsof cuts by the end of the year.  

In truth, I was only partially joking at my surprise they didn’t call an emergency meeting and cut yesterday. While the market is only pricing a 6% chance of a cut at the end of this month, I think that is a pretty good bet. Speaking of bets, the trader(s) who established that big SOFR options position earlier in the week is set to have a really good weekend!

To recap, we’ve had the softest inflation reading in 4 years and the market is anticipating the end of higher for longer.  As I have written consistently, my take is when the Fed starts cutting, the dollar will fall, commodity prices will rise, yields will start to decline, but if (when?) inflation reasserts itself, those yields will head higher.  And finally, stocks are likely to see support, but a very good point was made today that if prices stop rising, then so to do profit margins at companies and profits in concert.  Perhaps, slowing inflation is not so good for the stock market, even if it means that rates can be lowered.  Ultimately, there is still a lot to learn, and this was just one number, but boy, is everyone excited!

Did the BOJ
Take advantage of the news
And sell more dollars?

In the FX markets, the biggest mover, by far, was the yen, which at its high point of the session (dollar’s lows) had risen 4 full yen, or 2.5%.  The move was virtually instantaneous as can be seen in the chart below, and it is for that reason that I do not believe the BOJ/MOF was involved in the market.

Source: tradingeconomics.com

While I understand that the BOJ is pretty good at their jobs, it seems highly unlikely that the MOF made a decision in seconds and was able to convey that decision to Ueda-san’s team to sell dollars.  Rather, my sense is that since the short yen trade is so incredibly widespread as the yen has served as a funding currency for virtually every asset on the planet, the fact that the story about higher for longer may be ending led to instant algorithmic selling by hedge funds everywhere and a massive rally in the yen.  When the MOF was asked about intervention, Kanda-san, the current Mr Yen, gave no hint they were in and said only that people will find out when they release their accounts at the end of the month, by which time this episode will have been forgotten.  Remember, too, the yen has fallen, even after today’s rally, nearly 13% thus far in 2024.  It needs to rally a great deal further before it has any macroeconomic impact on Japan’s economy.  For my money, this was just a market that was caught long dollars and weak hands got stopped out, although Bloomberg is out with an article this morning claiming data showing it was intervention.  One thing in favor of the intervention story, though, is that this morning, USDJPY is higher by 0.6% and pushing 160.00 again.

And lastly, the story in China
Continues to give Xi angina
Domestic demand
Is stuck in quicksand
So, trade is his only lifeline-a
 
The other story that is on market minds this morning is about the Chinese data that was released last night.  The Trade Balance there expanded to $99B, much larger than last month and forecast.  A deeper look also shows that not only did exports grow more than expected but imports actually declined.  Declining imports are a sign of weak domestic demand, a harbinger of weak economic growth.  Later, they released their monetary data showing that loan growth, along with M2 growth, continue to slide as Chinese companies are reluctant to take on debt to expand.  While Xi’s government is pushing some money into the system, it is apparent that the collapsing property market remains a major obstacle to any sense of balanced economic activity in China.
 
Of course, this is a problem because of the international relation problems it continues to raise, notably with respect to charges of Chinese dumping of manufactured goods, and the proposed responses from both the US and EU on the subject.  While my crystal ball is somewhat cloudy, when viewing potential future outcomes of this situation it seems increasingly likely that both the US, regardless of the election outcomes in November, and the EU are going to impose tariffs and other restrictions on Chinese goods, if not outright bans.  Neither of these two can afford the social disruption that comes with domestic companies being forced out of business by subsidized Chinese competition.  While inflation looks better this morning than it did last month, its future is far less certain given this growing political attitude.
 
Ok, let’s see how markets have behaved in the wake of all the new information.  Arguably, the biggest surprise is that the US equity markets did not really have a good day with the NASDAQ tumbling -2.0% although the DJIA eked out a 0.1% gain.  Given the yen’s strength, it is no surprise that the Nikkei (-2.5%) fell sharply, and given the Chinese trade data, it is no surprise that the Hang Seng (+2.6%) rallied sharply.  But mainland shares were lackluster, and the rest of APAC was mixed with some gainers (Australia, India, New Zealand) and some laggards (South Korea, Taiwan, Malaysia).  European bourses, though, are all in the green as traders and investors there look to the increased odds of the US finally cutting rates, therefore allowing the ECB and other central banks to do the same, as distinct positives.  As to US futures, at this hour (7:00), they are unchanged to slightly higher.
 
In the bond market, after US yields fell sharply yesterday, with 10yr yields closing lower by 8bps, although they traded as low as 4.17%, a 12bp decline from the pre-data level, this morning, we are seeing a modest rebound with yields 1bp higher.  European sovereign yields are all firmer this morning as well as markets there closed before the US yields started to creep back up.  So, this morning’s 4bp-5bp moves are simply catching up to the US activity.  Lastly, JGB yields dipped 2bps last night as traders sought comfort in the decline in US yields.
 
In the commodity markets, yesterday saw a sharp rally immediately after the CPI print with gold jumping nearly $40/oz and back above $2400/oz, while oil had a more gradual rise, although is higher by nearly $1/bbl since the release.  This is all perfectly in line with the idea that the Fed is going to start to cut rates soon.  However, gold (-0.4%) is giving back some of those gains today.
 
Finally, the dollar, which fell sharply against all currencies after the CPI print, notably against the yen, but also against the rest of the G10 and most EMG currencies, is slightly softer overall this morning with both the euro (+0.15%) and pound (+0.3%) doing well and offsetting the yen’s weakness this morning.  Elsewhere throughout the G10 and EMG blocs the picture is far less consistent with CE4 currencies all following the euro higher although ZAR is unchanged as it suffers on gold’s weakness this morning. 
 
On the data front, this morning brings PPI (exp 0.1% M/M, 2.3% Y/Y) and its core (0.2% M/M, 2.5% Y/Y) although given yesterday’s surprisingly low CPI data and the ensuing market movements, it doesn’t feel like this number has the potential for much surprise.  After all, a soft reading would already be accounted for by the CPI and a strong one would be ignored.  We also see Michigan Sentiment (exp 68.5) at 10:00, but that, too, seems unlikely to shake things up.  There are no Fed speakers scheduled and really, the big thing today is likely to be the Q2 earnings releases from the big banks.
 
It has been an eventful week with Powell’s testimony being overshadowed by yesterday’s CPI data.  While the market is almost fully priced for a September cut, I think the best risk reward is to expect the Fed to act at the end of July.  Next week we hear from 10 Fed speakers, including Chairman Powell on Monday afternoon.  I would not be surprised to hear them start to guide markets to a July cut which would bring dollar weakness alongside commodity price strength.  As to bonds and equities, the former should do well to start, but as yesterday showed, and history has shown, equities tend to underperform when the Fed starts cutting rates.
 
Good luck and good weekend
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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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