Tag Archives: #Lagarde

Possibly Soaring

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So far this week, things have been boring
With data or news not outpouring
But starting today
More stuff’s on the way
With GDP possibly soaring

As well, we’ll hear from M Lagarde
Who’s promised her backbone is hard
It’s too soon to cut
As there’s still a glut
Of funds spread all over the yard

Heading into this morning’s data releases, we have had remarkably little on which to focus this week.  Flash PMI data yesterday was modestly better than expected, although manufacturing is still trending in recession around Europe and Asia.  Perhaps the biggest surprise was in the US where the manufacturing print was a solid 50.3, the first time it has been above the boom/bust line since last April.  However, that was not enough to quicken any pulses.

You can tell how dull things have been by the fact that the biggest news yesterday came from the Fed regarding the BTFP.  The BTFP (Bank Term Funding Program), you may recall, is the facility the Fed invented last March in the wake of the collapse of Silicon Valley and Signature banks.  The idea was they would lend money to the banks without the banks taking a haircut on the value of the collateral, so lending 100% of the collateral’s face value despite the fact the bonds were trading at 75 cents on the dollar.  It was designed to tide over weak banks and ostensibly had less stigma than borrowing from the Fed’s Discount Window, which is supposed to tide over weak banks.  But the funding was cheaper given the collateral price adjustment and over time, it garnered about $110 billion in utilization.  However, last November, when the market decided that the Fed was going to cut rates aggressively in 2024, the funding formula for these loans fell substantially below the IOER that the Fed pays to banks, reaching a spread of 60bps.  So, banks started using the BTFP to earn risk free cash.  Well, the Fed got tired of that game and as of today, raised the cost of funding thus eliminating the arbitrage.  And that was the most interesting thing in the markets yesterday!

But that was then.  Now we get to look ahead to a few key pieces of information starting with US Q4 GDP’s first reading (exp 2.0%) as well as Durable Goods (1.1%, 0.2% ex transport) and Initial (200K) and Continuing (1828K) Claims data.  That will be followed by the ECB’s press conference at 8:45 where Madame Lagarde will be able to reiterate her strong views that despite a very weak Eurozone economy, they have not yet solved the inflation problem and they are not going to cut rates anytime soon.  I have ignored the ECB official decision time as there is a vanishingly small probability that they will adjust rates from the current 4.0% level.

The question for market participants is whether any of this will matter, or if we still need to see the next crucial information, tomorrow’s PCE data and, of course, the FOMC meeting and press conference next Wednesday.  My sense is that much will revolve around that GDP print.  The Atlanta Fed’s GDPNow is forecasting a 2.4% print for Q4, still above the economists’ consensus, albeit not as far above as in Q3.  Given the market’s ongoing strong belief that the Fed is going to be aggressively cutting rates this year, an outcome at the GDPNow level or higher would certainly have a market impact, likely seeing a sell-off in bonds and a reduction in the probability of rate cuts going forward.  The natural extension of this would be a stronger dollar, weaker stocks and probably stronger oil prices as the demand side of the equation would be rising.

But in this topsy-turvy world where good news is bad, the converse is also likely true, a soft print will reinforce the ideas that the Fed is going to cut sooner and more aggressively which will have a short-term positive impact on stocks and bonds, although the dollar will suffer accordingly.

One of the market conversations about the Fed has been regarding the political implications of their moves and whether they may cut sooner just to try to avoid any appearance of a political bias.  But as I think about that, while the very small minority of people in this country who focus on the economy and markets will certainly have opinions on the subject, I would contend that for the vast majority of folks, whether the Fed cuts 25bps in March or May or June is just not going to change their lives nor change their vote.  Remember, monetary policy works with “long and variable” lags, so even if they do cut in March, it probably won’t start to feed through into any economic impact before the election.  The only conceivable impact would be that money-market fund yields would fall that 25bps, an annoyance but not a significant change.  My point is far too much emphasis is put on the potential political nature of this and I think it is overblown.

Turning to the overnight market activity, Chinese shares continue to benefit from the recent monetary and fiscal support that the government is adding with shares in HK and the mainland both higher by 2% overngith.  Meanwhile, Japanese shares were essentially unchanged, although that spread continues to narrow.  As to European bourses, they are softer this morning with the DAX (-0.5%) falling after weaker than forecast IFO data across the board indicating not only weak current conditions but weak prospects as well.  (As an aside, this is why it is so difficult to believe that Lagarde will hold off on rate cuts until the summer.  A weak Germany is a problem for the Eurozone.)   finally, after a mixed session yesterday, US futures are edging a bit higher as I type (7:45).

In the bond market, Treasury yields, which rose a few bps on the session yesterday, are essentially unchanged this morning but European sovereign yields are higher by 2bps across the board, perhaps in anticipation of something from the ECB.  JGB yields continue to creep higher as well, up another 2bps overnight as there is a growing confidence that the BOJ is going to exit their negative interest rate policy by April.  Right now I would still fade that bet.

Oil prices (+0.9%) have continued to rally with WRTI back above $75/bbl and Brent above $80/bbl.  Yesterday’s EIA inventory data showed surprisingly large drawdowns in crude and most distillates although gasoline inventories rose a bunch.  As well, it appears that the costs of transport are starting to drive the overall price higher with more and more shipping traffic avoiding the Red Sea.  Meanwhile, metals markets, after an ok day yesterday, are essentially unchanged this morning.

Finally, the dollar, which fell sharply yesterday, is mixed but broadly unchanged across the board.  Looking at my screen the largest move I see is KRW (-0.4%) with every G10 currency within 0.25 of yesterday’s closes.  At this point, the market is biding its time for today’s data as well as tomorrow’s PCE and next week’s FOMC meeting.  Unless that GDP number is a big miss in either direction, which I outlined above, I suspect a very quiet session here.

Right now, we are in a wait and see mode, so, let’s wait and see what the data brings and we can evaluate after the releases.

Good luck
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Magical Stuff

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A critical piece of inflation’s
Aligned with the broad expectations
Of where it will be
In one year and three
As this feeds Jay’s model’s foundations
 
So, yesterday’s data release
That showed expectations decrease
Is magical stuff
And could be enough
To make sure all tight’ning will cease

 

While Thursday’s CPI report remains the key data point this week, there are plenty of other data points that get released on a regular basis that can give clues to how the economy is behaving, and perhaps more importantly to how the Fed’s reaction function may respond.  One of the lesser-known inflation readings is published by the NY Fed each month and shows Consumer Inflation Expectations one year ahead.  As can be seen in the below chart from tradingeconomics.com, the trend has been very positive (lower inflation expectations) for the past two years.

This must warm Powell’s heart as it appears his efforts at anchoring inflation expectations continue to work.  When combining this data with comments from two Fed speakers, Bostic and Bowman, who both indicated some satisfaction with the recent trajectory of inflation and were comfortable with the idea of rate cuts later this year, it is easy to see why yesterday was such a bullish one for risk assets.

Perhaps of more interest, at least to me, was the Consumer Credit Change report which showed that in November, consumer credit rose by a very large $23.75B!  This was the largest increase in twelve months and plays to the idea that people are using their credit cards to purchase consumer staples because they cannot afford them anymore.  On the flip side, given the way economic growth is measured, this will be a positive for Q4 as it implies more ‘stuff’ is being bought.  To my eye, this seems to be a short-term positive, but offers the chance of being a medium-term negative as delinquency in loans is typically not seen in a beneficial light and there are already many stories of people being overextended on their credit cards.

As well, Tokyo CPI was released overnight at 2.4%, 2.1% Core, which was right on expectations, but more importantly, indicative of the fact that inflation pressures in Japan are quickly ebbing.  Perhaps the BOJ’s view that they did not see sustainable price inflation despite almost 2 years of CPI prints above their 2.0% target, is turning out to be correct.  This has huge implications as it means there is little reason for the BOJ to consider exiting its current monetary policy combination of NIRP and QE combined.  As an aside, 10-year JGB yields fell 2bps last night and are currently at 0.58%.  This does not seem like a panicky level, nor one that is necessarily going to attract a lot of internationally invested Japanese money back home.  For all the JPY bulls out there, this is not a good sign.

Away from that news, European data continues to show Germany in a world of hurt, with IP falling -0.7% in November, far worse than expected and the 6th consecutive decline in the series.  However, Eurozone unemployment fell a tick, back to 6.4% and the lowest in the history of the series.  Meanwhile, the ECB just published a report indicating that the inflation suffered by the Eurozone was due almost entirely to supply chain disruptions with a small dose of energy price spike.  It had nothing to do with their policies!  To an outsider like me, this sounds like they are preparing to cut rates as soon as they can.  I wouldn’t be surprised if Madame Lagarde was on the phone with Chairman Powell right now!

And that’s really all we have seen overnight.  After yesterday’s strong rebound in the US, the overnight equity picture was somewhat mixed with Japan having a good session on the weak inflation data although the Hang Seng continues to slide.  Overall, there was no unifed trend in Asia with gainers and losers both.  European shares, though, are in the red this morning led by Spain’s IBEX (-1.75%) although that is the outlier worst performer.  (It seems that a single stock, Grifols, a pharma name, is down -28% on some recent reports about manipulated accounting and that is dragging the whole index lower.). However, US futures are also softer, down about -0.4% at this hour (8:00).  There is still much discussion if last week’s sell-off was just a reaction to a huge late 2023 rally, or the beginning of something much bigger.

In the bond market, Treasury yields have edged up 1bp this morning but remain either side of 4.0% for now.  European yields, though, are higher across the board once again, by between another 5bps and 6bps.  Now, this move is based on yesterday’s close, which saw a drop in yields at the end of the session there.  While the trend in European yields looks higher, they are little changed from this time yesterday.

Oil prices (+3.1%) are rebounding nicely from yesterday’s sharp decline.  You may recall that Saudi Arabia cut its selling price yesterday and the market read that as a sign of weak demand.  However, this morning, that story has faded and continuing tensions in the middle east seem to be having a bigger impact.  This is confirmed by the fact that gold (+0.35%) is rebounding as well although the base metals are mixed this morning with copper slightly higher and aluminum slightly lower.

Finally, the dollar is a touch stronger this morning, but not really by much.  Versus the G10, I see gains of about 0.15% or so with NOK (+0.25%) the exception as it is responding to the rebound in oil.  Versus the EMG bloc, the picture is clearer with almost all these currencies a bit softer, albeit between -0.2% and -0.4% generally.  The dollar continues to be the least interesting asset bloc around for now and is likely to remain so until the Fed starts to actually change policy rather than simply hint at it.

On the data front, we see the Trade Balance (exp -$65.0B) and we have already seen NFIB Small Business Optimism print at a better than expected 91.9.  But, while that is a nice outcome, recall that the index is back at levels below Covid and only above those seen in 2008 and 1980!  Fed Vice-Chair for regulation, Michael Barr speaks at noon, but my guess is he will be right in line with the recent commentary that things look good, but they are not done yet.

As I wrote yesterday, with the bulk of the focus on Thursday’s CPI print, I expect that while markets might be choppy, there will not be much directional information overall.  

Good luck

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Sufficiently

Posted on by 
Said Madame Lagarde, I don’t care

‘Bout dovishness seen over there

Though I’m not omniscient

We need rates sufficient-

Ly high til inflation is rare



The Old Lady’s governor, too

Expressed that no cuts were in view

But can both withstand

More slowing than planned

And, with their tough talk, follow through?

A little housekeeping to start this morning.  Today will be the last poetry until January 2nd when I will publish my ‘crystal ball’ viewings in a long-form poem.  For all my readers, thank you for reading and have a wonderful Christmas, Hannukah (I know it’s’ over), Kwanzaa, Festivus or whichever holiday is important as well as let’s hope 2024 is a fantastic new year.

So, let us review yesterday’s activity, and then, more broadly, the state of things as we come to the end of the year.

Arguably, the biggest news yesterday was not that the ECB left rates on hold, which was universally expected, but that Madame Lagarde tried very hard to continue to sound hawkish despite the Fed’s turn on Wednesday.  “Based on its current assessment, the Governing Council considers that the key ECB interest rates are at levels that, maintained for a sufficiently long duration, will make a substantial contribution to this goal. The Governing Council’s future decisions will ensure that its policy rates will be set at sufficiently restrictive levels for as long as necessary.” [emphasis added.]

As well, she explicitly mentioned that there was no discussion of interest rate cuts in the meeting.  The hawks on the committee managed to get a bone thrown their way with the announcement of a phased exit from the PEPP program starting in the second half of next year.  At the same time, their staff projections for GDP growth and inflation were all reduced slightly for 2024 and 2025 with low numbers penciled in for 2026.  She maintained that inflation has been “too high for too long”, clearly true, and has been unwilling to consider anything but their inflation fight.

Alas, this morning’s Flash PMI data releases make ugly reading with French, German and the Eurozone overall reading weaker than last month and weaker than expected.  The Eurozone growth engine has been stalling for quite a while despite falling energy costs.  And now, in the wake of the Fed turning dovish, energy costs are rebounding which will almost certainly negatively impact the continent’s growth trajectory.  Maybe Lagarde can hold out for another month, but I suspect if the data continues to erode in the manner, it has recently, the ECB will recognize that the worst is over and it’s time to alter policy, just like the Fed has done. As well, given the economy in Europe is in far worse shape than here in the US, I expect that they will be cutting more quickly as 2024 progresses.  That will not help the euro, but that is a story for some time next year, not for the remainder of this one.

At almost the same time, the BOE also maintained their policy rate and also indicated that they were not anywhere near ready to cut rates.  In fact, 3 voters wanted a 25bp rate hike, which given inflation in the UK is the highest in the western world, with core still at 5.7%, makes sense.  But, as on the continent, economic activity continues to stumble along, with manufacturing, according to this morning’s Flash PMI reading of 46.4 in recession although Services activity, 52.7 does seem to be rebounding.  However, here, too, I believe the gravitational pull of a dovish Fed is going to quickly weigh on the BOE and we are going to see a pivot in the first half of next year amid weaker growth and slowing inflation.

One final note from yesterday was that Retail Sales were a bit stronger than expected, rising 0.3% and failing to show the slowdown that would be expected to help reduce inflationary pressures.  And just think, that was before the Fed pivot, which has ignited a massive risk-on rally in assets and likely will juice things even more in the short-term.

The result of these policy decisions is that stocks are rallying pretty much everywhere in the world, bonds are rallying pretty much everywhere in the world, commodities prices are rallying, and the dollar is falling.  Not only that, I see nothing that is likely to change those views until somewhere toward the end of Q1 2024 at the earliest.

But let’s step back for a moment and consider the medium-term impacts of all this change.  Remember this, a soft-landing is merely the last stop in the cycle before a hard landing.  The soft-landing narrative is clearly the majority view and driving force in markets as 2023 comes to a close.  But is that a realistic outcome?  

I think a very strong case can be made that we have seen the bulk of the disinflationary forces that are coming as the combination of Covid driven supply chain issues being fixed and higher interest rates / QT has weighed on marginal demand.  It has been a fun story while it lasted and has certainly cheered markets.

But structural issues remain, many of which are outside any central bank’s abilities to address adequately.  Consider what I believe is the biggest structural change, the turn from capital-focused economic policies to labor focused economic policies.  This is inherently inflationary and regardless of what Powell or Lagarde or Ueda or anyone in that chair does, this change is going to continue.  It is a political change, and one that is only getting started.  Politically, we call it populism, and one need only read the papers to recognize this is the new world.

For 40 years, since the Reagan/Thatcher leadership, the world has seen low inflation from a combination of demographics and globalization creating downward pressure on wages and reduced taxation increasing the return on capital.  This led to the financialization of western, especially the US, economies and expanded the wealth/income gaps that are prevalent around the world today.  

But this is changing, and changing far more rapidly than the current governments in power would like to see or believe.  As I wrote earlier, 2016 was a test run for what is looming in 2024.  Consider the populist views of recent election outcomes in Argentina and the Netherlands as well as the rise in the polls of the National Front in France, AfD in Germany, and the strength of both Trump and RFK Jr in the US, with populism as the driving force.  2023 saw more labor unrest in the US than any time in the past 20 years and harkens back to conditions in the 60’s and 70’s.  The big difference between now and then is that union membership has declined so dramatically in the interim.  Do not be surprised to see unions rise again in popularity.

But populism drives more than labor unrest, and ultimately rising wages, it also encourages governments to consider trade barriers and tariffs, both of which drive consumer prices higher.  And populism is very easy for governments to adopt because it sounds so good.  Consider the key tenets; buy domestic goods, limit immigration and tax the rich so they pay their fair share.  We will hear some version of these policies in every country around the world in 2024, and not just western nations, but communist bloc countries as well.  

If this is the future, and I believe it is, then the current risk rally is merely a hiatus before things turn much worse.  In a populist driven society, profit margins are going to decline, and capital will flee to where it feels safest.  That may be whichever nations push back against this trend, although they will be few and far between, and things like real assets, commodities, and real estate.  While I believe this will be the general trend, from an FX perspective, given everything is relative there, strength or weakness will depend on the relative decisions made in each nation.  Arguably, the less populist the decision outcomes, the stronger the currency, but ex ante, there is no way to know how that will turn out.  If I had to bet now, I would suggest that the nation least susceptible to this wave is Japan, a truly homogenous society, and that bodes well for the yen going forward.

In the meantime, as I head off, here are today’s data points with Empire State Manufacturing just released at a much worse than expected -14.5.  We are due to see IP (exp 0.3%), Capacity Utilization (79.1%), and the Flash PMI’s (Mfg 49.3, Services 50.6).  Through the rest of the month, the most important data point will be the PCE data on the 22nd, but arguably, Powell already told us it is not going to be hot, that’s why he turned away from higher for longer.

Today is triple witching in the equity markets, with stock options, future options and futures all expiring, so volume should be high and movement can be surprising.  But the trend right now is positive for risk assets, and I believe that will continue through the holidays and into January.

Good luck, good weekend and have a wonderful holiday

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Dreamlike

Posted on by 
The ECB hiked twenty-five
But Madame Lagarde tried to drive
The idea they’d hike
Again was dreamlike
And so, euro-dollar did dive

Then last night some Chinese reports
Showed there was some growth there, of sorts
The PBOC’s
Continuous squeeze
Of rates, too, has hammered yuan shorts

Starting with a quick recap of the ECB meeting, as I had believed, they hiked rates by 25bps which takes the Deposit rate to 4.00%, the highest level since the euro was created in 1999.  It seems Madame Lagarde’s rationale was similar to my own, which was essentially, this was the last chance to raise rates before the recession in Europe really gets going at which point further rate hikes will be incredibly difficult politically.  However, by essentially explaining they were done, with inflation running well above both the current interest rate structure as well as their 2.0% target, Lagarde undermined any support for the single currency which fell sharply yesterday after the announcement and has been unable to show any signs of life since then.  Current market pricing shows a 38% probability of another hike this year before an eventual reduction in the rate structure by the middle of 2024.  However, my take is that if the recession spreads further, the ECB will be quick to cut rates.  Ultimately, I continue to believe the euro is going to have a very difficult time going forward.

Turning our attention east, the Chinese monthly data dump was released last night and virtually every single measure beat expectations, even the property investment.  None of the beats were very large, but I guess the question has become are analysts and investors overly bearish on China (or perhaps the question is can we trust Chinese data)?  For instance, IP rose 4.5% Y/Y, vs. 3.9% expected; Retail Sales rose 4.6% Y/Y vs. 3.0% expected; Property Investment fell -8.8% Y/Y vs. -8.9% expected and the Unemployment Rate fell to 5.2% rather than remaining unchanged at 5.3%.  The only outlier was Fixed Asset Investments which rose 3.2% rather than the 3.3% expected.  The market response to this was quite interesting.  The yuan was little changed, although it remains well above its recent lows with USDCNY hovering around 7.2800.  The CFETS fixing continues to be pushed toward a lower dollar, although the spread between the fixing and the onshore market has narrowed slightly to 1.4% from its recent levels above 1.9%.

As I mentioned yesterday, the Chinese cut their RRR by 0.25% trying to inject more liquidity into the economy and they have also been pushing up offshore CNY interest rates which are now equal to USD interest rates so there is no carry benefit in shorting the CNY offshore.  This, too, will help eliminate some of the downward pressure on the yuan.  In fact, it appears that much of the recent policy focus has been to prevent the yuan from weakening much further.  I guess if you are trying to convince other countries that they can use the yuan for payments and holding it is safe, it really cannot be seen falling sharply.  I suspect that the PBOC will be doing everything they can to support the currency going forward.  In a bit of a surprise, Chinese shares were the worst performers overnight, with all the main indices there in the red while markets elsewhere in Asia (Nikkei +1.1%, Hang Seng +0.75%, ASX 200 +1.3%) and Europe (DAX +1.0%, CAC +1.6%, FTSE 100 +0.8%) are all higher.  As it happens, US futures are little changed this morning after a strong equity performance yesterday.  So, all in all, I would say risk is in favor today.

This risk attitude is evident in bond yields as well as they are rising with investors moving from bonds to stocks.  Treasury yields are higher by 3.5bps, while in Europe, yields are all higher at least 6bps with Italian BTPs seeing the most selling and a rise of 7.5bps.  Arguably, if the ECB has finished its tightening cycle, which it seems to have done, and inflation remains as high as it is, the value of bonds should decline.  This movement is logical based on what appears to be the new narrative. 

A quick aside on Japan, where you may recall that on Monday, the yen strengthened and JGB yields rose after comments from BOJ Governor Ueda regarding the possibility that they would have enough information to potentially end ZIRP there.  It turns out that was not Ueda-san’s intention, and rather he thought his comments were benign.  It seems there is no intention to adjust policy anytime soon.  The market response was seen in FX where the yen fell -0.3% and is now pressing to 148.  I suspect 150 is coming soon, although further intervention at that level cannot be ruled out.

Turning to commodities, oil (+0.5%) continues to rally and is now solidly above $90/bbl.  The other gainer today is gold (+0.4%) but base metals are softer.  A possible train of thought here is that rising oil prices will both force interest rates higher through the inflation channel as well as undermine economic growth, so the industrial sector is getting double-whammied in the short-term.  As with energy, the long-term prospects remain quite positive for base metals as production is just not going to be able to keep up with demand given the lack of investment in the sector since the ESG movement began a decade ago.  Even if it is recognized that this must change, it will take years before new production can come online which should continue to be supportive of the sector overall.

Finally, the dollar is mixed this morning, with the EMG bloc seeing half gainers and half laggards although the largest movement is less than 0.2%.  In other words, nothing is going on here.  Similarly, in the G10, other than the yen mentioned above, movement has been mixed with no real substance in either direction.  Given the FOMC meeting next week, it appears that traders are unwilling to position themselves too much in either direction.  Net, this week, the dollar did fall a bit, but remains well above its recent lows.

Yesterday’s Retail Sales data was once again quite hot, rising 0.6% for headline and ex-autos, which just goes to show that there is a lot of money still sloshing around the system.  As well, the Claims data was solid again with 220K Initial Claims, less than forecast and certainly not showing any weakness in the labor market.  Today brings a bunch of secondary data with Empire Manufacturing (exp -10.0), IP (0.1%), Capacity Utilization (79.3%) and Michigan Sentiment (69.0).  The Citi Surprise Index continues to push higher which continues to indicate that economic activity in the US remains solid.  While a recession is clearly going to arrive at some point, for now, it remains a distant prospect.  With that in mind, do not think that the Fed is going to go soft anytime soon and that ongoing higher for longer is very likely to help support the dollar overall.

Good luck and good weekend

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Results May Be Dire

Posted on by 
It turns out inflation was higher
Though no one would call it on fire
The problem, alas
Is food, rent and gas
Show future results may be dire

But CPI’s yesterday’s news
Today it’s Christine and her views
Will she hike once more
Though growth’s on the floor
Or will, all the hawks, she refuse?

Yesterday’s CPI report could be termed luke-warm, I think, as the headline number was a tick higher than expected at 3.7%, while the core M/M number was also a tick higher than expected at 0.3%, although the Y/Y core number was right at the 4.3% expectation.  This provided fodder for both sides of the inflation discussion, with the inflationistas all claiming that higher CPI is coming, and we have bottomed while the deflationistas claimed that the results were insignificantly different from expectations and, oh yeah, rental prices are still falling so they are certain CPI will follow lower.  My go-to on this subject is always @inflation_guy and he explained (here) that some areas were hot and some not so much but does agree that any further declines in the CPI are likely to be quite small if they come at all.  I am in the camp that the new inflation level is somewhere in the 3.5%-4.0% area and short of a drastic recession, it will be extremely difficult to change that.

The stock market was certainly confused by the data as it initially sold off 0.5%, rebounded through most of the day only to see another late day decline and finish up very slightly higher overall.  In other words, it certainly doesn’t seem as though opinions were changed.  Treasury yields did edge a bit lower, falling 3bps, although this morning they have backed up by 1bp.  And the dollar finished the day net stronger vs. the G10, but actually net weaker vs. the EMG bloc.  All in all, I would argue we didn’t learn that much.

This brings us to today’s key story, the ECB meeting.  After the leaked story about the newest ECB forecasts calling for CPI above 3.0% next year, the market priced a greater probability of a hike today, it is still 65%, but net, have only one more hike priced in before the ECB is finished.  Madame Lagarde’s problem is that inflation is running hotter than in the US while their interest rate structure is 150bps lower and growth is very clearly rolling over.  The stickiness of European inflation has been quite evident and shows no signs of changing.  So what will she do?

Given Lagarde’s political background, as opposed to any central banking background, I expect that she will see the writing on the wall with respect to economic activity in the Eurozone, and if the ECB is going to be able to raise rates at all, this is probably the last chance.  By the October meeting, the European recession will be quite evident and her ability to hike rates then will be heavily circumscribed.  As such, I see 25bps today and that is the end, regardless of what her comments afterwards are.  

Trying to consider how the markets will react to this leads me to believe that European equities will soften a bit, although ahead of the meeting they are higher by about 0.3% across the board.  It also implies to me that we could see European sovereign yields creep higher (although right now they are lower by about 1bp across the board) as the inflation fighting stance alters before inflation retreats, and ultimately, I think the euro suffers as investors decide that there are better places to put their money.  In fact, I expect this opens the door for the next leg lower in the single currency, perhaps down to 1.05 before it finds a new ‘home’.

But wait, there’s more!  In fact, we have a plethora of data being released today in the US as follows:

Retail Sales0.1%
-ex Autos0.4%
Initial Claims225K
Continuing Claims1693K
PPI0.4% (1.3% Y/Y)
-ex food & energy 0.2% (2.2% Y/Y)

Source: Bloomberg

For the market, and the Fed, I expect the Retail Sales number will be critical as last month we saw a very hot read, 0.7% while the market was looking for just 0.4%, and the ex Autos number was even hotter at 1.0%.  If we were to see another strong number here, especially if the Claims data continues to point to strength in the labor market, the Fed will certainly take note.  And while they may not hike next week, it would likely increase the odds of a November hike substantially.

Those are the key macro stories to watch today but there is one micro story that is worth noting and that is that the PBOC has been quite active recently in its efforts to prevent further renminbi weakness.  This morning they cut the reserve requirement ratio by a further 0.25% for banks in China and they also increased the issuance of bills offshore in Hong Kong thus pushing CNY rates higher there and pressuring those who would short the currency.  Finally, it appears that they have instructed several of the large state-owned banks to essentially intervene in the spot market at their direction, although the banks are the ones holding the risk.   So far, all their activity this week has pushed USDCNY lower by just 1.0%, so having some effect, but hardly reversing the longer-term trend weakness in the currency.  My take is, like the Japanese, they are more worried about the pace of any decline than the decline itself.  But in the end, unless we see some macro policy changes by either or both China and the US, the trend here remains for a weaker renminbi.

Ahead of the ECB meeting, markets have been quiet overall.  The dollar is mixed with an equal number of gainers and losers in both the G10 and EMG blocs and none of the movement more than 0.3%.  We have already discussed both stocks and bonds which leaves only commodities, which is the exception to the rule of limited movement today as oil (+1.5%) has jumped further with WTI pushing to just below $90/bbl.  While metals markets are mixed and little changed overall, the oil story is going to be a problem for both central bankers and politicians alike if the price continues to rise.  As we head into election season in the US, rising gasoline prices, and they are rising fast, will likely cause panic in the current administration.  Alas, they no longer have an SPR to offset the OPEC+ production cuts, they used that bullet, so the only hope for lower prices seems to be a dramatic decline in demand, and that will only occur if we have a deep recession, something else that politicians are desperate to avoid.  I remain bullish on oil overall, although we have seen a pretty big move over the past month, nearly 11%, so some consolidation wouldn’t be a big surprise.

And that’s really it for today.  At 8:15, the ECB releases its decision and statement.  At 8:30 the US data drops and then at 8:45 Madame Lagarde holds her press conference.  So, plenty to look forward to in the next hour or so.

Good luck

Adf

Having Some Fits

Posted on by 
While all eyes are on CPI
Some other news may now apply
The Germans and Brits
Are having some fits
As they both, to growth, wave bye-bye

The other thing that we have heard
Is ECB forecasts have stirred
What was 3%
They’ve had to augment
So, Thursday, a hike is the wor

Clearly, the top story today will be the release of the August CPI data with the following expectations: Headline 0.6% M/M, 3.6% Y/Y and ex food & energy 0.2% M/M, 4.3% Y/Y.  The headline number has been boosted by the rise in energy prices, although it is important to understand that the bulk of the gains in oil’s price are not going to be in this number, but in next month’s release.  As well, oil prices continue to rise, up another 0.65% this morning and now above $89/bbl.  Too, gasoline prices, the place where we feel this rise most directly, continue to climb right alongside crude.  This release will have the chance to alter some views on the Fed meeting next week, but it will need to be a big miss one way or the other to really have an impact, I think.  While I am not modeling inflation directly, certainly my anecdotal evidence is that prices are continuing to rise at better than a 4% clip for ordinary purchases, whether in the supermarket or at a restaurant or retail store.

But perhaps, the more interesting things today have come from Europe and the UK, with three key, somewhat related stories.  The first was the release of the UK monthly GDP data which fell -0.5%, far worse than anticipated as IP (-0.7%), Services (-0.5%), and Construction (-0.5%) all were released with negative numbers for July.  What had been a seemingly improving outlook in the UK certainly took a hit today and has placed even more pressure on the BOE.  Despite the weaker than expected growth situation, there is, as yet no evidence that inflation is really slowing down very much leaving Bailey and company in a pickle.  Tightening further to fight inflation while the economy declines is a very tough thing to do.  But letting inflation run is no bowl of cherries either.  It should be no surprise that both the pound (-0.2%) and the FTSE 100 (-0.5%) are under pressure today.

The other two stories come from Frankfurt where, first, the German government is apparently set to downgrade its outlook for full-year 2023 GDP to -0.3% from its previous assessment of +0.4%, which was quite weak in its own right.  Apparently, poorly designed energy policy is coming back to haunt the nation as manufacturing activity continues to diminish under the pressure of the highest energy prices in Europe.  Unfortunately for Germany, and likely for Europe as a whole, unless they adjust their energy policies such that they can actually generate relatively cheap power and create a hospitable environment for manufacturing, I fear this could be just the beginning of a longer-term trend.

The other story here is not an official change, but a leak from ECB sources, which indicates that the ECB’s inflation estimate for 2024 will now be above 3.0%, from its last estimate right at 3.0%.  The implication is that the hawks continue to push for another rate hike at tomorrow’s council meeting.  In the OIS market, the probability of a hike tomorrow has risen to 67% from about 50% yesterday.  As a reminder, this is what Madame Lagarde told us back in July, “We have an open mind as to what decisions will be in September and subsequent meetings…We might hike, and we might hold. And what is decided in September is not definitive, it may vary from one meeting to another.”  With this in mind, it appears that some members are trying to put their thumb on the scales and get a push toward one more hike.  Especially given weakness in German economic activity, if they don’t hike tomorrow, it will get increasingly difficult to justify more hikes later, so in the hawks’ minds, it’s now or never.

In truth, I think that is an accurate representation because if we continue to see slowing growth in Europe, Madame Lagarde, who is a dove by nature, will be quite unwilling to weigh on growth and push up unemployment even if inflation won’t go away.  With this in mind, I’m on board to see the final ECB rate hike tomorrow.

Not surprisingly, today’s news did not help risk appetites at all.  Equity markets, after yesterday’s US declines (especially in the tech sector) were lower throughout most of Asia and are currently lower across all of Europe.  In fact, the losses on the continent are worse than in the UK, with an average decline of about -0.9%.  Pending higher interest rates amid weakening growth are definitely not a positive for equities.

However, investors have not been running to bonds as a substitute.  Instead, bond yields are higher pretty much across the board, with Treasury yields up 2.5bps while European sovereigns have seen yields climb between 3.5bps (Bunds) and 7.0bps (BTPs).  This has all the feel of rising inflation fears that are not likely to be addressed in the near term.

I already touched upon oil prices leading the energy space higher, but given the sliding views of economic activity, it is no surprise to see metals prices softer this morning with both precious and base metals under pressure.  While the long-term prospects for commodities overall, I believe, remain quite bullish, if (when) we do go into recession, I expect a further price correction.

Finally, the dollar is a bit stronger against all its G10 counterparts and most EMG counterparts this morning.  Granted, the movement has been modest so far, which given the importance of today’s data release, should be no surprise.  But my take is that a hot CPI print, especially in the core, will see the dollar rise further as the market starts to price in at least one more rate hike by the Fed, probably in November.  At the same time, if the CPI number is cool, then look for the dollar to give back a bunch of its recent gains as market participants go all in on rate cuts in the near future.  It is that last part of the concept with which I strongly disagree.  While the Fed may have reached its terminal rate, there is no evidence that they are even thinking about thinking about cutting rates.  However, that is my sense of how today will play out.

Good luck

Adf

Still Avante-Garde

Posted on by 
As always, when Chairman Jay speaks
Each hawk and each dove caref’lly seeks
The words that best suit
Their story, and mute
All others with varied techniques

Every hawk in the market heard these words, right at the beginning of Powell’s speech Friday morning and rejoiced [emphasis added], “we are prepared to raise rates further if appropriate, and intend to hold policy at a restrictive level until we are confident that inflation is moving sustainably down toward our objective.”

However, the doves didn’t need to wait long to find their counterpoint, with Powell giving them fodder in the very next paragraph, [emphasis added], “given how far we have come, at upcoming meetings we are in a position to proceed carefully as we assess the incoming data and the evolving outlook and risks.”

So, which is it?  Here is the link to the speech, so you can make up your own mind if you so choose but be prepared, if you listen to the punditry, you will hear both sides and likely no clear decision.  With that in mind, my take is that there is still far more hawkishness than dovishness around the table at the Eccles building.  Much of the speech focused on the fact that while things were certainly better than the peak inflation period last year, there is still a long way to go before they feel confident they have achieved their goal.  And one other thing, Powell made it clear that the goal remains 2%.  All this talk of raising the target seems like it will get no hearing at all for the time being.

A quick look at equity markets on Friday shows that the initial impression of the speech was the hawkish view as stocks fell pretty sharply right away.  However, after falling about 0.7% in the first hour, buyers returned, and the major indices all closed nicely higher on the day.  Of course, the irony of that outcome is higher equity prices beget easier financial conditions which implies even more tightening by the Fed.  But whatever.

Then later, said Madame Lagarde
This job that we have is so hard
The future’s unclear
And though we’re sincere
We’re clueless, though still avant-garde

Much later Friday, Madame Lagarde explained her updated framework for how the ECB is going to be handling things in the future.  The very best thing she said was that they would act with humility as they proceed.  And while it would be great if that were to be the case, my 40 years of experience tells me it is unlikely to work out that way.

The essence of her speech was to identify that the world has changed and that old economic relationships may no longer be viable.  As I have written many times about all the central banks, each of them has a series of econometric models by which they steer their course.  The problem is those models have over time been proven to be completely worthless.  And more disturbingly, anytime someone with a different viewpoint has a chance to be nominated to enter the club, they are shot down immediately.  There is virtually zero willingness to truly think outside of the box of their making.  While Lagarde preaches that they will be humble going forward, it seems highly unlikely they will consider anything that is not completely orthodox, even as a thought experiment.  And to my mind, that is the exact opposite of humility.

At any rate, Lagarde’s speech was very late in the market day and did not seem to have much impact at all.  Thus concludes the recap from Friday’s activity.  Now let’s turn to this morning.

In China, old President Xi
Keeps trying to force, by decree
A rally in stocks
By banning sales blocks
And halving the transaction fee

While it is getting tiresome to have to write about China yet again, it remains the other major story in the markets.  Last night, the government unveiled yet another set of measures to try to support the stock market there with only marginally more success than seen last week.  (As an aside, does it seem strange to anyone else that a communist country with state control over most aspects of life is keen to support the bastion of capitalism that is a stock market?).  

The latest effort included three steps; a 50% cut in the transaction tax, down to 0.05%; a limit on new listings (to prevent more supply); and a ban on sales by controlling shareholders if those companies have not paid dividends in the past three years or are trading below their IPO price.  These were announced before the market opened and the initial response was a 5.5% jump compared to Friday’s closing levels in the CSI 300.  Alas, it was a very short-lived gain with half that evaporating in the first 10 minutes of trading and the end result a gain of only about 1% on the day.  Certainly, better than a decline, but clearly not what President Xi had in mind.

Ultimately, the problems in China go far beyond the level of stamp duty on stock trades.  There are fundamental problems in the economy’s structure as well as the demographic and debt overhangs that exist there.  Despite the much ballyhooed efforts by Xi to adjust the Chinese economy away from its mercantilist economic model, that is still the predominant process there.  It is with this in mind that I continue to look for a much weaker renminbi going forward, and an eventual move to 7.50 and beyond.  

As to the rest of the equity markets, currently everything is in the green, with Japan having a great day (+1.7%) and all of Europe higher by between 0.50% and 1.00%.  US futures, too, are firmer this morning, although only just at this hour (7:20), about 0.2% across the board.  As there is a ton of data to come this week, I suspect that traders will be waiting for more information before making their next big bets.

In the bond market, things are quite benign with no major government market having seen a yield change of even 1 basis point this morning.  There are some gainers and some losers, but for all intents and purposes, bonds are unchanged on the day.  The one thing to note, though, is that the US Treasury curve inversion is growing again, back to -86bps, after having traded to as low as -65bps less than two weeks ago.  I feel like this movement simply adds to the confusion over the imminence of a recession, although I definitely believe one is coming by early next year.  Of course, we will learn far more about the economy this week given the data to be released.

In the commodity space, oil is marginally softer this morning, back just below $80/bbl, although there seems to be an increasing effort by OPEC+ to continue to restrict supply as they fear a recession coming.  Metals prices are generally little changed this morning, again, with market behaviors driven by the uncertainty over the week’s upcoming news.

Finally, the dollar is also mixed this morning, with a nice mix of gainers and losers across both the G10 and EMG blocs.  I feel the bias will be for a stronger dollar given my take on Powell’s comments as being hawkish, but as I explained, there was plenty of fodder for both arguments.

Turning to the data, there is a lot this week as follows:

TodayDallas Fed Manufacturing-19.0
TuesdayCase Shiller Home Prices-1.65%
 JOLTS Job Openings9450K
 Consumer Confidence116.2
WednesdayADP Employment 198K
 Advance Goods Trade Balance-$90.0B
 GDP Q22.40%
ThursdayInitial Claims235K
 Continuing Claims1705K
 Personal Income0.30%
 Personal Spending0.70%
 Core PCE Deflator0.2% (4.2% Y/Y)
 Chicago PMI44.1
FridayNonfarm Payrolls168K
 Private Payrolls150K
 Manufacturing Payrolls3K
 Unemployment Rate3.50%
 Average Hourly Earnings0.3% (4.3% Y/Y)
 Average Weekly Hours34.3
 Participation Rate62.60%
 Construction Spending0.50%
 ISM Manufacturing47.0
 ISM Prices Paid44.0

Source: Bloomberg

So, as can be seen there is a ton of stuff to digest this week.  On top of that, we do hear from a few Fed speakers, but I think that given we just got Powell’s views, the data will be far more important than anything from a few regional bank presidents.  While obviously, Core PCE is critical, as it is their key inflation metric, I continue to look at the payroll data as the key for Powell to believe that he has not broken anything yet.  Once that data starts to fade, we can look for a change in tone from the Fed.  But until then, higher for longer remains the key, and the dollar should continue to benefit.

Good luck

Adf

A Gaggle of Bankers

Posted on by 
At altitude 8000 feet
A gaggle of bankers will meet
All eyes are on Jay
And what he might say
Regarding the Fed’s balance sheet

Now, pundits galore have opined
But something we need bear in mind
Is policy tweaks
Are still several weeks
Away, and will like be refined

Well, at 10:00 this morning, Chairman Powell will speak to the world regarding his latest views on “Structural Shifts in the Global Economy.”  At least that is the theme of the entire event where there will be numerous speeches by central bankers including Madame Lagarde later today, as well as papers presented by economists.  The reason this event is so widely discussed is in the past, Fed Chairs have used the forum to signal a shift in policy.  

Is that likely today?  This poet’s view is no, it is unlikely.  The message from the July meeting was that the Fed was still concerned about inflation running too hot and that the higher for longer mantra still applied.  Since then, the data has, arguably, been somewhat better than expected, although certainly not universally so.  At the same time, 10-yr yields are some 40bps higher and the S&P 500 is lower by about 4% since the last FOMC meeting, market moves that indicate investors are listening.  I do not believe Chairman Powell is keen to rock the boat.  As well, I don’t believe he feels the need to imply any major changes are necessary and I have a feeling that he is actually going to speak about the global economy, and not the US one specifically.

Summing up, I have a feeling this is going to be a complete non-event, with no useful information forthcoming, at least from Powell.  As it happens, Madame Lagarde speaks at 3:00 this afternoon NY time, and there is considerably more uncertainty as to the ECB’s path forward given the fact that the economic data in the Eurozone continues to be weak (today, German GDP in Q2 was confirmed as 0.0% Q/Q, -0.2% Y/Y, with Private Consumption also at 0.0% and the Ifo sentiment fell to 85.7, several points below expectations) while inflation remains far above their target.  While the ECB hawks are still claiming it is far too early to consider a pause in rate hikes, the ECB doves have been clear they are ready to stop.  Remember, too, Lagarde is a dove at heart.  It would not be difficult to believe that Lagarde discusses the slowing growth in China and the assumed knock-on effects for Europe as a rationale for expecting inflation to continue to fall without further ECB actions.

But as always, this is merely speculation ahead of the speeches, which is why we all listen.  Away from this meeting, though, investors are demonstrating some concerns about the overall situation, at least as evidenced by recent market activity.

Yesterday, in what was clearly something of a surprise to most pundits, equities sold off sharply in the US, led by the NASDAQ which was down -1.9%.  The surprise comes from the fact that the Nvidia earnings the night before were so strong and the stock rallied sharply on the news.  And this weakness was spread across all the major US indices.  Adding to the confusion was the fact that the US data yesterday generally pointed to more economic growth, with lower Claims data, and a strong Durable Goods -ex transport print with survey data looking up as well.  I guess this is a ‘good news is bad’ situation as continued economic strength informs the idea the Fed is not going to change their stance on higher for longer.

That weakness fed into Asia, where markets were lower across the board led by the Nikkei (-2.05%).  But in Asia, the interesting thing was that China announced, during the session, additional support for the property market by altering some mortgage and tax rules to encourage more home buying as Beijing tries to grapple with the increasing speed of the property implosion.  Alas for President Xi, the positive impact in the stock market lasted…10 minutes only!  After that, selling resumed and all the major indices in Asia finished lower on the day.  Now, European bourses have reversed that trend and are higher by roughly 0.6% across the board, perhaps anticipating a Lagarde ease, while US futures at this hour (7:30) are edging higher by 0.2% or so.

In the bond market, yields, which had fallen sharply earlier in the week, bottomed on Wednesday and are now higher in the US and throughout Europe.  While the move largely occurred in the US yesterday, with a 5bp bounce, and this morning we are little changed, Europe is seeing yields climb by 5bp-6bp across the board today.  The one place where yields remain dull is Japan, which has seen the 10yr JGB hover either side of 0.65% for the past week or two.

In the commodity space, oil (+1.5%) is rebounding again, arguably on the better than expected US data.  This is consistent with firmer prices in base metals, which are rising despite the rise in yields.  Ultimately, what this tells me is that there remains a great deal of uncertainty as to the near future regarding the economy.  The battle over whether a recession is coming soon or never coming continues apace.  The thing about commodities is that the supply piece of the puzzle continues to be undermined (pun intended) by ESG focused investors and governmental actions, and so the ultimate direction remains higher in my mind. 

Finally, the dollar is mixed to slightly stronger this morning, with most of the G10 a touch weaker vs. the greenback except for NOK (+0.4%) which is clearly benefitting from oil’s rally.  In the EMG sector, ZAR (+0.9%) is the outlier on the high side as allegedly traders are betting on increased investment flows to the country in the wake of the expansion of the BRICS nations.  (As an aside, can somebody please tell me why adding Argentina, a nation with a history of hyperinflation and serial debt defaulter, would inspire confidence in a BRICS currency?). But other than the rand, movement in this space has also been limited, arguably with everyone waiting for Powell.

On the data front, just ahead of Powell’s speech, we get the Michigan Sentiment Survey (exp 71.2), but that will clearly be overshadowed by Powell.  While I anticipate very little activity in the market ahead of 10:00, I also anticipate very little after the speech as I don’t believe he is going to change any perceptions at this point.  There is still a lot of data before the next meeting, another NFP, CPI and PCE reading, so it is too early to look for a change.  

Good luck and good weekend

Adf

A Suggestion

Posted on by 
Nought point five percent
Is not a rigid limit
It’s a suggestion

At least that is the word we got last night from Kazuo Ueda, BOJ Governor when he announced some surprising policy changes.  No longer would 10-yr JGBs be targeted to yield 0.0% +/- 0.50%, which in practice had meant a 0.50% cap.  Going forward, the BOJ would buy an unlimited amount of JGBs at 1.0%, if necessary, as its new framework.  Perhaps the most humorous part of the concept was the suggestion that they always saw the 0.50% cap “as references, not as rigid limits, in its market operations.”  That’s right, after 7 years of a seemingly explicit cap on JGB yields, with the BOJ willing to buy unlimited amounts in order to prevent yields from climbing, now they mention it was merely a suggestion, a guideline rather than a hard limit.  It is commentary of this nature that tends to undermine investor trust in central bankers.

Given the surprising nature of the policy changes, although they left their O/N financing rate at -0.10%, it should be no surprise that the market had some large, short-term responses.  JGB yields jumped 10bps on the news, trading to a new 9-year high at 0.575% before slipping back a few bps to close the week.  The Nikkei, meanwhile, fell nearly 2.5% in the immediate aftermath of the decision, but rallied back all afternoon there to close lower by just -0.4%.  It turns out the financial sector benefitted greatly as higher rates really helps them.  As to the yen, it saw substantial short-term volatility, as ahead of the meeting it weakened nearly 1.75%, trading above 141.00, but very quickly reversed course and rallied > 2% as the dollar briefly fell to 138.00.  In the end, though, the yen is just a hair stronger on the day now, back near 139.50 where things started.

The lesson, I think, is that policy shifts tend to have very immediate consequences, but the longer term impacts, especially in the currency market where we have a lot of moving pieces between the Fed, ECB and BOJ, will take longer to play out.


In Europe, inflation remains
The issue that’s caused the most pains
But growth there is stalling
So, Christine is calling
For slowing the rate hike campaigns

“We have an open mind as to what decisions will be in September and subsequent meetings…We might hike, and we might hold. And what is decided in September is not definitive, it may vary from one meeting to another,” Lagarde said.It was with these words that Madame Lagarde informed us the rate hiking cycle in the Eurozone may have ended.  Despite the fact that core CPI remains above 5.0% while their deposit rate is now at 3.75%, seemingly not high enough to effectively combat the inflation situation, it is becoming ever clearer that the European growth story is starting to slide.  This is in direct contrast to the US growth story, which based on yesterday’s extremely robust data, shows no signs of fading.

But as I have written numerous times in the past, once the Fed is perceived to have stopped raising interest rates, it was clear the ECB would be right behind them.  The entire basis of my stronger dollar thesis has been that other central banks will find it very difficult to tighten policy aggressively to fight inflation if the Fed has stopped doing so.  

In the end, no country really wants a strong currency as the mercantilist tendencies of every country, seeking to increase exports at the expense of their domestic inflation situation, remains quite strong.  Faster growth with higher inflation is a much preferred economic outcome for essentially every government than slower growth with low inflation.  Inflation can always be blamed on someone else (greedy companies, Ukraine War, OPEC+, supply chain disruptions) while faster growth can be ‘owned’ by the government.

So, between the ECB and BOJ, we did see further policy tightening in line with the Fed’s actions on Wednesday.  Arguably, the difference is that the US economic data continues to be quite strong, at least on the surface.  Yesterday’s first look at Q2 GDP printed at 2.4%, much higher than expected and showing no signs of the ‘most widely anticipated recession in history.’  The strength was seen in Government spending (IRA and CHIPS Act), Private Domestic Investment (which is directly related to that as companies build out new plant infrastructure) and Services, i.e. travel and restaurants.  Once again, I will say that as long as the US economy continues to show growth of this nature, and especially as long as the Unemployment Rate doesn’t rise sharply, the Fed will have free rein to continue to raise rates going forward if inflation does not settle back to their 2% target.

One thing to consider regarding the central bank comments and guidance is that virtually every one of them has ended the strict forward guidance we had seen in the past.  Rather, data dependence is the new watchword as none of them want to be caught out doing the wrong thing.  Alas, the result is that, by definition, if they are looking at trailing data, they will always be doing the wrong thing.  I expect that one of the key features of the past 40 years, ever reducing volatility in markets, is going to be a victim of the current framework.  It is with this in mind that I suggest hedging financial exposures, whether FX, rates, or commodities, will be far more important to company balance sheets and bottom lines than they have been in the past.

Ok, let’s see how investors are behaving today as we head into the weekend.  We’ve already discussed the Japanese market, but Chinese shares, both onshore and in HK, had a very strong day as there was more talk of official policy support for the property market there.  Ultimately, it is very clear they are going to need to spend a lot more money to prevent an even larger calamity.  European shares, though, are generally little changed this morning with investors preparing to take the month of August off, as usual there.  Finally, US futures are higher this morning after what turned out to be a surprising fall in all three major indices yesterday.  The overall positive data plus indication that the Fed may be done seemed to be the right conditions for further gains.  But markets are perverse, that much we know.  We shall see if US markets can hold onto these premarket gains.  I would say that a lower close on the day would be quite a negative for the technicians.

In the bond market, yesterday saw US 10-year yields jump 15bps, its largest rise this year, although it is giving back about 4bps of that this morning.  European sovereigns, though, are little changed this morning and have not been subject to the same volatility as the Treasury market given the far less exciting economic picture there.  If the ECB is truly finished, my take is yields there could slide a little over time.

In the commodity markets, oil (-0.35%) is a touch lower this morning, but the uptrend continues.  This certainly seems to be more about reduced supply than increased demand, although with the US data, the demand picture looks better.  Interestingly, both gold (+0.6%) and copper (+1.0%) are higher this morning despite the dollar holding its own.  Yesterday saw a sharp decline in both and I think there is a realization that was overdone.

Speaking of the dollar, it is modestly softer today after a strong gain yesterday.  In the G10, GBP (+0.6%) is the leader followed by NOK (+0.5%) although AUD (-0.6%) and NZD (-0.3%) are taking the opposite tack.  The pound seems to be benefitting from anticipation of next weeks’ BOE meeting where 25bps is a given, but the probability of a 50bp hike seems to be creeping up.  Meanwhile, NOK is just following oil’s broad trend with WTI just below $80/bbl now.  Meanwhile, Aussie seems to be suffering some malaise from the BOJ actions, at least that’s what people are saying although I’m not sure I understand the connection.  Perhaps it is the idea that higher JPY yields will result in unwinding the large AUDJPY carry trades that are outstanding.  

However, the emerging markets have seen a much wider dispersion of performance with much of the APAC bloc under pressure last night on the back of the strong dollar performance yesterday, while we are seeing strength in LATAM and EEMEA currencies this morning, which really looks an awful lot like simple trading activity with positions getting reduced after yesterday’s dollar performance.

In addition to the GDP data yesterday, we saw a lower-than-expected Initial Claims print at 221K while Durable Goods orders blew out on the high side at 4.7%!  Again, lots to like about the US data right now.  Today we see Personal Income (exp 0.5%) and Spending (0.4%) along with the Core PCE Deflator (0.2% M/M, 4.2% Y/Y) and finally Michigan Sentiment (72.6).  based on yesterday’s results, I would expect the Income and Spending data to be strong along although PCE is probably finding a bottom here.

In the end, even if the Fed has stopped hiking, although with the economy still showing strength that is not a guaranty, I find it hard to believe that the ECB will go any further, and the tendency around the world will be to slow or stop tightening as well.  I still like the dollar in the medium term.

Good luck and good weekend

Adf

Resolutely

Posted on by 
Said Jay to the world through the Press
We’ve certainly had some success
But patience is key
As resolutely
We stop any signs of regress

Does this mean that next time we meet
Our actions will be a repeat?
The answer is no
We’re not certain, though
We could if inflation shows heat

And what about Madame Lagarde
Have she and her minions been scarred
By Europe’s recession
Or will their suppression
Of growth lead to outcomes ill-starred

By this time, you are all almost certainly aware that the Fed raised the Fed funds rate by 25bps as widely expected.  You may not be aware that the FOMC statement was virtually identical, with only a change in the description of economic growth from ‘modest’ to ‘moderate’, apparently a slight upgrade.  This was made clear when Chair Powell, at the press conference, explained the Fed staff was no longer forecasting a recession in the US.  Perhaps the following Powell quote best exemplified the outcome of the meeting, “We can afford to be a little patient, as well as resolute, as we let this unfold,” he said. “We think we’re going to need to hold, certainly, policy at restrictive levels for some time, and we’d be prepared to raise further if we think that’s appropriate.”  

So, what have we learned?  I think we can sum it up by saying nothing has changed the Fed’s mindset right now.  They continue to focus on the fact that inflation remains above their target and will continue to implement policies that they believe will address that situation. 

The thing that makes this so interesting is everybody seems to have a different interpretation of what that implies.  The two broad camps are 1) this was the last hike as inflation continues to fall and they are already hugely restrictive compared to their historical activities; and 2) given the upgrade in economic forecast, and the fact that inflation seems set to remain higher than target for a long time yet, there are more hikes to come.Given the math that goes into the CPI data, it is quite easy to forecast Y/Y CPI if you assume a particular M/M figure for the next period of time.  BofA put out a very good chart showing the potential evolution of headline CPI going forward.

The implication here is that unless the M/M data falls to zero or negative, CPI is going to start climbing again.  The Fed clearly knows this as does the market.  The only disconnect is the question of how the Fed will respond in the various cases.  Remember, too, that oil and gasoline prices have risen 13.7% and 11.2% respectively in the past month.  The idea that the energy component of CPI will do anything but rise sharply this month seems absurd.  As such, I expect that the Fed will continue to lean toward another hike going forward.

The problem they have had is that the pass-through from Fed rate hikes to the economy has been greatly diminished by their previous policy of excessive ZIRP.  It is estimated that roughly 80% of US home mortgages have fixed rates below 4%, with half at 3% or less.  At the same time, the average duration of corporate debt has lengthened to 6.4 years as the refinancing activity that occurred during the ZIRP period saw extension of tenors widespread.  As such, other than the Federal government, who managed to shorten the duration of their outstanding debt during the period of ZIRP, most borrowers are in pretty good shape and not impacted by the Fed’s policies.  In fact, they are earning much more on their cash balances.  The point is, there is a case to be made that the Fed can maintain ‘higher for longer’ for quite a while without having a significantly deleterious impact on the economy.  Perhaps the soft landing is possible after all.

Now, if they continue to hike rates, and there are a number of analysts who believe we are heading to 6% or beyond, things may change.  We are already seeing a significant diminution of demand for bank loans, which while that may not bother large corporates, implies that the SME sector is going to break first.  Does the Fed care about them?  They will only care when the Unemployment Rate rises substantially.  This comes back to why I believe that NFP is still the most important data point, regardless of the inflation discussion.  Summing it up, the Fed will see two more CPI, PCE and NFP reports before they next meet on September 20th.  It is impossible, at this time, to estimate their actions with this much more data still to be digested.  However, if my inflation view is correct, that it will remain stickily higher, I see a very good chance of at least one more Fed funds rate hike.

A quick look across the pond shows that the ECB will be making their latest rate decision this morning with the market expecting a 25bp hike.  Unlike in the US, the OIS market is pricing in one further hike after today’s and then that will be the end of the cycle.  But…can Madame Lagarde continue to tighten policy if Europe is actually in a recession?  We already know that Germany is in a recession, and forecasts for Q2 GDP in Europe, to be released next week, are at 0.3%.  The Citi Economic Surprise Index remains mired at -136.7, a level only seen during Covid and the GFC, hardly the comparisons desired.  I believe it will be much tougher for an additional rate hike by the ECB unless the data story turns around quickly, and I just don’t see that happening.  Overall, it is this dichotomy in economic activity that underlies my bullish thesis on the dollar.

At any rate, the market response to the FOMC has been one of sheer joy.  Well, that and the fact that there are still some pretty good earnings results getting released, at least relative to recent expectations, if not on a sequential basis.  But it is the former that matters as that is what gets priced into the market.  So, equity markets, after yesterday’s breather in the US where they didn’t rise sharply, are mostly higher around the world.  Both the Hang Seng and Nikkei rallied nicely, and European bourses are quite robust this morning, with many exchanges higher by > 1%.  US futures, too, are in the green, with the NASDAQ showing great signs of strength.

Meanwhile, bond yields have edge a touch lower virtually everywhere with most of Europe seeing declines between 1bp and 2bps, although Treasury yields are less than 1bp lower this morning.  There appears to be little concern that Madame Lagarde is going to spoil the party and sound uber hawkish.  Even JGB’s are a touch softer, -0.4bps, as the market prepares for tonight’s BOJ announcement.  However, there is absolutely nothing expected out of that meeting.

In the commodity space, oil (+1.1%) is higher again this morning as are gold (+0.25%) and the base metals (CU +0.1%, Al +0.6%).  The soft(no) landing scenario seems to be gaining some traction here.  Either that, or the dollar’s weakness today, which is widespread, is simply being reflected as such.

Speaking of the dollar, it is definitely on its back foot as the market is essentially saying the Fed is done.  It is softer vs. the entire G10 bloc, with NOK (+1.05%) leading the way on the back of oil, but SEK (+0.9%) and NZD (+0.7%) also rising nicely alongside the commodity space.  Even the euro, which has no commodity benefit whatsoever, is firmer this morning by 0.5% as the market awaits Madame Lagarde.

In the emerging markets, the picture is similar with almost every currency firmer vs. the buck led by HUF (+1.1%) and ZAR (+0.8%).  The rand is clearly a commodity beneficiary, while the forint has gained after a story about the ECB being willing to consider Hungarian legislation that will avoid the need to recapitalize the central bank despite its recent losses.  Meanwhile, the laggard is KRW (-0.25%) which seems to have responded to the widening interest rate differential between the US and South Korea.

On the data front, we see Q2 GDP (exp 1.8%, down from 2.0% initially reported), Durable Goods (1.3%, 0.1% ex Transport), Initial Claims (235K) and Continuing Claims (1750K) along with several other tertiary figures.  There are no Fed speakers on the docket for the next week and I suppose that given the relative calm following yesterday’s meeting, there is not a great deal of near-term concern they need to change any views.  I suspect that if tomorrow’s PCE data surprises, we could start to hear more soon.

Today, the mood is risk on and sell dollars.  Barring a remarkable surprise from Lagarde, I would not fade the move.

Good luck

Adf