Tag Archives: #lowerdollar

Ain’t Hunky-Dory

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For President Xi it appears
The stock market’s shed enough tears
So, he’s set to meet
The finance elite
And likely to box all their ears

As such, I expect we shall see
The Hang Seng will start on a spree
With New Year’s approaching
A little more coaching
By Xi, for a rally, is key

The big news overnight was that Chinese equity markets rebounded sharply (Hang Seng +4.0%, CSI 300 +3.5% CSI 1000 +7.0%) after the news that President Xi Jinping would be meeting with market regulators to find out what is going on there.  Banning short sales has not yet been effective nor has increased purchases by specific state funds.  According to Morgan Stanley, foreign investors sold $2.4 billion in Chinese equities in January, arguably a key driver of the market’s recent weakness there.  But the fact that Xi is getting involved directly has traders believing that more support from the government is on its way, hence today’s big rally.

While that is all fine and well for equity investors, the far more important question for the rest of us is will this stock market support help the Chinese economy as well?  Or will that continue to meander along at a weak growth pace?  Of course, it is far too early to know the answer to this question but given that the preponderance of Chinese individual wealth is tied up in real estate, not equities, I expect that this will have far less impact on the economy there than is hoped by both Xi and the traders.  After all, one of the key reasons so many in the US care about the stock market is that so much of our 401K investments are in equities, a rally shows up in our accounts daily.  But in China, that same situation does not hold.  Will a rally in stocks, if it even comes, be enough to sway the average person’s thinking there that things are getting better?  I have my doubts.

A turn to the interest rate story
Shows things there just ain’t hunky-dory
Yields just won’t stop rising
And that’s neutralizing
The thought rate cuts are mandatory

Friday morning, 10-year Treasury yields traded as low as 3.82% prior to the release of the NFP report.  This morning, they are trading at 4.16%, 34 basis points higher and the largest two-day yield rally since the covid volatility in March 2020.  Prior to that, it was 1981 when yields moved that far that fast.  Adding to Friday’s NFP story, yesterday’s ISM Services report was not only stronger than expected at 53.4, but the Prices index jumped to 64.0, its highest in a year and hardly a comforting thought for Chairman Powell and his fight against inflation.

At this point, the Fed funds futures market has lowered the March rate cut probability to 16.5%, and some of the punditry, although not yet any Fed speakers, have raised the question if another hike might be in order if things continue on their recent trajectory.  I assure you that the equity market has not priced in the possibility of a rate hike anywhere in the next 2 years at least.  Let’s just say that next week’s CPI report is going to be quite closely watched by everyone as if what I have seen as recent stickiness continues to exert itself, and with the economy seeming to be ticking over quite nicely, then the narrative could well change.  It is not impossible for the Fedspeak to turn even more hawkish if we were to see CPI rise 0.4%, a rate that is far too high for Fed comfort.  And that, my friends, would likely not be well-received by the equity market or risk assets overall.  While I have no special insight into how this data is going to evolve, I think the reaction function is clear.

Ok, let’s look at the overnight session beyond Chinese stocks.  In what cannot be that surprising after US equities struggled and given its recent negative correlation to Chinese stocks, the Nikkei fell -0.5% while the rest of Asia was mixed with some gainers (India, Taiwan) and some laggards (Korea, Australia).  However, the story in Europe is a little brighter with gains most everywhere except Germany, which is flat on the day after mixed data, with a blowout Factory Orders result of +8.9%, but the Construction PMI falling to 36.3.  Contradictory data leading to no movement.  As to US futures, at this hour (7:45) they are essentially unchanged on the day.

In the bond market, it seems traders are sitting on the sidelines after the bloodbath described above as 10-year Treasury yields are unchanged on the day and in Europe, the sovereign bonds are higher by a mere 1bp-2bps across the board.  We saw a similar lack of movement in Asia as well, despite the fact that the RBA, at their meeting last night, sounded somewhat hawkish although left policy rates on hold as universally expected.  As the treasury market is clearly leading the way globally, we will need to get some new information here, I think, before we see any substantive movement again.  Since the next big piece of data is CPI in one week’s time, it could be a quiet week for bonds.

In the commodity market, oil (+0.6%) is bouncing slightly this morning although it remains far lower than levels seen last week.  Gold (+0.1%) is also edging higher along with the industrial metals although there has been no strong catalyst here today given the lack of substantive rate movement.  Perhaps there is some optimism from the Chinese stimulus story, but that feels quite premature.

Finally, the dollar is a touch softer this morning, although only just.  While the euro has been unable to bounce, we have seen some modest gains in the pound (+0.25%) and Aussie dollar (+0.25%) as well as the renminbi (+0.3%).  In addition, the LATAM bloc is very modestly firmer this morning but generally, most of the movement is of that 0.25% magnitude or less.  This feels very much like a trading response to a powerful rally over the past two days.

There is no hard data to be released today but we do hear from three more Fed speakers, Kashkari, Collins and Mester, all this afternoon.  Yesterday, Chicago Fed president Goolsbee strayed from the Powell message, indicating he still believed a cut in March was possible, but he is not a voter this year and nobody really paid any attention.  After yesterday’s data, it would be hard to believe that any of these three would sound dovish, but you never know.

Overall, when looking at the dollar, as long as the inflation story has reawakened and is driving yields in the US, it is hard to see coming weakness.  This is especially true given the economic weakness we continue to see elsewhere in the world.  Today feels like a reaction, not a trend in the making, and I expect that the dollar has better days ahead for as long as inflation is once again the driving force.

Good luck
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Seems Like a Crisis

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The Chinese have not finished yet
Their efforts to counter the threat
Of weaker stock prices
Which seems like a crisis
So new triple R rates were set

But one thing I don’t understand
Is while CCP’s in command
Just why do they care
‘Bout stocks anywhere
Perhaps communism ain’t grand

Yesterday, the Chinese government announced that there would be up to CNY 2 trillion of support for Chinese equity markets in their latest effort to stanch the 3-year bear market.  But apparently, that was not enough as last night Pan Gongsheng, the PBOC governor, announced they were reducing the Reserve Requirement Ratio (RRR or triple R) in order to free up additional loan capacity for the banks.  The move, a 0.50% cut in the ratio will ostensibly release another CNY 1 trillion into the economy.

There are two issues I’d like to address here.  First, given the property market in China remains under significant pressure as activity still seems to be lethargic, at best, and the economy overall is not really expanding at a significant pace, why do they think that allowing more loans will encourage people to take more loans.  After all, last week, they left the Loan Prime Rates unchanged, so were not trying to encourage more activity, and it is not clear that loan capacity has been a constraint in any manner during the past several years.  As global growth remains slow overall, it is entirely possible, if not likely, that there is just reduced demand for Chinese manufactures around the world right now.

The second issue is a bigger picture question, why does the Chinese Communist Party care at all about the stock market?  After all, a reading of Das Kapital would explain that there is no place for private ownership at all in a communist system and by extension, no place for shareholders.  The state is supposed to own everything.  My conclusion is that Xi, and the entire CCP, are full of s*it regarding their belief in communism.  In fact, I would contend that is true for every communist regime on the planet.  Rather, those in charge in communist regimes merely see it as the most effective way to command all the power and wealth personally and could care less about the concepts Marx espoused.  In the end, I would argue that the human condition is one where acquiring as much power and wealth as possible is the driving goal for most people.  While many people have much smaller ambitions, the sociopaths who rise to leadership roles in politics know no bounds as to what they believe is their due.  Just sayin!

Regardless of the underlying rationale, though, the PBOC had the desired impact as both the Hang Seng (+3.6%) and the CSI 300 (+1.4%) rallied sharply on the news.  As well, the Nikkei (-0.8%) slid a bit further as it seems there had been a growing position by CTAs and hedge funds in the long Japan/short China trade which I illustrated yesterday.  If China is rebounding, I expect that Japanese shares will have further to slide in the near-term.  As well, after another day with some record high closings in the US yesterday, European bourses are all in the green nicely this morning with the DAX (+1.3%) leading the way although the other main indices are also higher by about 1%.  The laggard here is the UK (+0.4%) and I attribute this movement to the Flash PMI data which was released this morning showing that continental growth continues to slide, hence increasing the chance of a rate cut sooner, while UK data was a bit better than expected, and well above 50 across the board, implying the BOE will lag any rate cuts going forward.  And happily, as I type at 8:00, US futures are all nicely in the green as well.

In the bond market, Treasury yields are a touch softer this morning, down 2bps, but still hanging right around the 4.10% level which has been a pivot for the past week.  European sovereigns have seen yields decline about 3bps across the board after that soft PMI data, while UK Gilts have moved the other direction on the stronger data there.  Of more interest, I think, is that JGB yields have jumped 5bps overnight and are now back above 0.70%.  It seems that there is an evolution in thinking regarding Ueda-san’s comments after the BOJ meeting Monday night, and the belief that they will be exiting NIRP in April is growing stronger.  We shall see.

Commodity prices are higher across the board this morning with oil (+0.3%) continuing to find support, arguably from the troubles in the Middle East, although some short-term issues like the shuttering of a Russian export terminal after a Ukrainian attack have also had an impact.  But metals markets are universally higher this morning as well, with gold (+0.25%) far less impressive than copper (+2.0%) or aluminum (+0.9%) as positivity from the Chinese RRR cut and the potential for stronger growth on the mainland feed through the markets.

Finally, the dollar is under pressure this morning across the board.  This is true in the G10 bloc with the euro and pound both firmer by 0.5%, while the yen (+0.8%) and CHF (+0.8%) are having even better days.  Similarly, the EMG bloc has seen gains across the board with the leader ZAR (+1.1%) on the back of those metals gains, but strength in PLN (+0.8%), CZK (+0.7%) and HUF (+0.65%) showing their high beta with respect to the euro, and gains in APAC currencies (KRW +0.4%, SGD +0.3%, CNY +0.3%) and LATAM currencies (MXN +0.6%, BRL +0.8%) as it is unanimous regarding the dollar’s weakness.

On the data front, today brings only the Flash PMI data (exp 47.9 manufacturing, 51.0 services) and the EIA oil inventories.  There are no Fed speakers due to the quiet period, so I foresee market activity focused on equity earnings releases although none of the big names are due today.  Right now, the dollar is under pressure amid ongoing belief that the Fed is going to cut ahead of other central banks.  Until that story changes, I expect that we could see a bit more dollar weakness.  But in the end, tomorrow’s GDP and Friday’s PCE data are going to really drive views.  Look for a quiet one today.

Good luck
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Now Estranged

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“Something appears to be giving”
Said Waller, the true cost of living
So, bonds rallied hard
The dollar was scarred
But stocks were quite unreactive-ing

The narrative clearly has changed
With hawks on the Fed now estranged
Is everything better?
As world’s largest debtor
We need low rates to be arranged

Fed Governor Chris Waller, one of the erstwhile hawks on the FOMC was covered in white feathers yesterday as he explained his latest perception that the Fed was on a path to achieving their 2% inflation goal as Q3’s expansive GDP was clearly an outlier and the data he cited showed economic growth slowing toward trend just below 2%.  The other Fed speakers on the day did not back him up specifically, and in fact, Governor Bowman explained her base case was the Fed needed to hike still further to be certain inflation was under control.  However, the market only had eyes for Waller and has heard the following message from the Fed, ‘we have finished hiking, and the next move will be a cut.’  Although this had been a building narrative, until yesterday there had been consistent pushback from virtually every Fed speaker with the higher for longer mantra.  However, the current belief set is that higher for longer has just been buried and that lower rates are in our future.  Let the celebrations begin because the Fed has achieved the much discussed, though rarely achieved, soft-landing.

However…it is still a bit premature, to my mind, to celebrate accordingly.  In fact, just yesterday the Case Shiller Home Price Index showed an annual rise of 3.9%, which although 0.1% less than forecast, also shows that the widely claimed decline in house prices due to higher yields, has not materialized.  And consider, if yields are set to go lower, the idea that house prices are going to fall and feed into lower inflation seems absurd unlikely.

But logic has never been an important part of any market narrative, and this time is no different.  The fact that declining bond yields (Treasuries fell 6bps yesterday and a further 5bps in the aftermarket) and the fact that the dollar, as measured by the DX, fell 0.5% led by USDJPY falling nearly 1.5% to its lowest level since September, has eased financial conditions thus supporting economic activity and inflation, is of no importance to the narrative.  Once again, we have heard from some big-name traders, Bill Ackman in this case, claiming that the Fed is now going to cut well before the market is pricing, predicting the first cut in March 2024. The market response to this has been for Fed funds futures to price a 40% chance of a March cut and a 75% chance of one at the May meeting.

And maybe all this is correct.  However, as I wrote yesterday, I believe that we are going to see a significant additional amount of federal government largesse to help prop up the economy, and that is not going to push inflationary pressures lower, the opposite in fact.  As is always the case, nothing matters until it matters, and right now, the only thing that matters is that the narrative is all-in on rate cuts coming soon to a screen near you.  While we could easily see further short-term weakness in equity markets as portfolios rebalance after a huge equity rally this month, it certainly seems like a push higher in risk assets is on the cards into Christmas.

As we consider the price action from yesterday and overnight, the thing that really stands out is that the US equity markets did so little on this very clear change in tone from a key Fed speaker.  Had you told me this was going to be Waller’s attitude prior to the session, I would have expected US equity markets to rally by 1+% each, with the NASDAQ really embracing the idea of lower rates.  But while the three major indices all closed in the green, it was only at the margin, +0.1% – +0.3% with a very late day rally.  Yes, futures are pointing higher this morning, up about 0.3% across the board, but again, this is somewhat unimpressive.  Perhaps the market has already priced in this idea, hence the 10% rally in November.

There is another wrinkle in this narrative as well, and that is that APAC shares are underperforming in both China and Japan.  Regarding the former, the Hang Seng (-2.0%) fell again as continuing concerns over Chinese corporate growth and profitability weigh on the index with Meituan reporting poor results.  On the mainland, despite hopes that the government was going to do more to support the property market, thus far it has been all talk, and no action and investors are getting tired of waiting.  Europe, however, is having a better go of it this morning, excluding the UK, where continental indices are all nicely higher, at least 0.5% with some as much as 0.9%.  

Not surprisingly, European debt markets are rallying as European sovereigns are following the US lead, ignoring the pleas from ECB speakers that higher for longer remains the path forward.  As such, we are seeing further declines on the order of 4bps – 6bps across the continent, matching US yield declines for the past two days.  Yields in Asia, though, are quite interesting with some very different narratives playing out there.  Starting with Japan, which saw yields fall 9bps last night, back to their lowest level since September, we heard from BOJ member Seiji Adachi that it was premature to consider exiting ultra-loose monetary policy amid global economic uncertainties and the end of the aggressive rate hikes in the US.  That seems counter to what had been the building narrative regarding Ueda-san’s next move.  Australia saw yields decline 14bps but in New Zealand, the decline was much more muted, just 2bps, after the RBNZ left rates on hold, as expected, but was far more hawkish in their statement than expected and hinted at potential further rate hikes.  

Turning to the commodity markets, oil continues to rebound, rallying another 1.8% this morning and recouping all its recent losses as confusion still reigns over the OPEC+ meeting tomorrow, or perhaps to be delayed again.  As well, it seems that a massive early winter storm closed ports in the Baltic and so oil shipments have been interrupted there for the time being.  Gold, though, has been the big story in commodity markets as it exploded higher yesterday after the Waller comments, jumping $30/0z (1.5%) to levels last seen in May and once again approaching its all-time highs of $2085/oz.  The market technicians are getting quite excited as they see a break there as having potential for a much larger run higher.  A case can be made that this is not a vote of confidence in the Fed’s anticipated future handling of inflation, but for now, we can simply attribute it to lower interest rates around the world.

Finally, the dollar has taken a straight-right to the chin and is reeling against virtually all its counterparts, both G10 and EMG. While we have seen a bit of a rebound this morning, since Monday’s close, EUR (+0.3%), GBP (+0.5%) and JPY (0.65%) have all rallied nicely, and that is after giving up some of those gains overnight.  We saw similar movement in the EMG bloc with CNY (+0.3%), PLN (+0.3%) and BRL (+0.8%) all responding positively to the Waller comments.  As I have been saying recently, if the Fed is truly done, then the dollar is likely to suffer, at least until such time as the other central banks fall in line.

On the data front, in addition to the Case Shiller Home Prices yesterday, we saw Richmond Fed Manufacturing which disappointed at -5.0 (exp 1.0), yet another sign that growth is waning.  It is data like this that has Waller in the mindset that slowing growth will lead to lower inflation.  Of course, rising home prices would certainly be a crimp in that theory.  Today we see the second look at Q3 GDP (exp 5.0%) with Real Consumer Spending expected at +4.0%.  We also get the Fed’s Beige Bok at 2:00pm and Cleveland Fed president Mester speaks at that time.  It will be interesting to hear if Mester, a very clear hawk, confirms the Waller thoughts or tries to push back alongside Governor Bowman.

For now, while the dollar has bounced slightly this morning, as long as the narrative remains the Fed is done and that cuts are coming soon, you have to believe the dollar is going to fall further from here.  If pressed, I would suggest USDJPY has the furthest to decline, but the fact that we have already had pushback from the BOJ implies that they are not that unhappy it remains weak.  After all, it supports their corporate sector and helps keep inflation higher, which remains one of their goals.

Good luck

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Vaporized

Posted on by 
The powers-that-be are concerned
That Argentine voters have spurned
Advice they’ve provided
And rather decided
It’s time some new lessons were learned

And so, we cannot be surprised
The media pundits advised
Milei should step back
And take a new tack
Lest talking points get vaporized

It has been quite a slow session overnight.  There has been precious little new in the way of data or commentary of note with respect to the current economic story.  At the same time, the Thanksgiving holiday has trading desks thinly staffed and the Fed is noteworthy in its absence from the tape.  As such, the news cycle has been filled with the OpenAI saga, something far outside the scope of this poet, the ongoing political infighting that is a constant thrum in the background, and one very interesting thing, the mainstream response to the election of Javier Milei as president of Argentina.

Given the dearth of other news, and the fact that I believe this has the opportunity to be quite impactful going forward, I thought I would take a little time and discuss this further.

According to Wikipedia, which in this case I have no reason to disbelieve, Milei, while new to politics, is a serious economist.  He has earned two masters degrees in the subject, taught at university and is a widely published author on the subject.  The point is, he has very clear ideas on how economies work from a theoretical perspective and having grown up in Argentina during one of its earlier hyperinflations, from a practical aspect as well.

What makes all this so fascinating is the deluge of articles that have been published in the WSJ, Bloomberg, CNN, the New York Times, et al. which are quite keen to highlight that his views are highly unorthodox and will fail dramatically, dragging the nation into an even deeper hole.  In fact, I cannot find a single mainstream media source that believes his ideas will succeed.  However, 56% of the voters in Argentina, who are actually living through the economic disaster of the mainstream views, thought differently.

Perhaps the clearest signal of this disagreement is that the Merval, Argentina’s main equity index, rose 7.1% yesterday on the news of his election.  One need not be a conspiracy theorist to understand that if Milei is successful in righting the Argentine ship by throwing out the current orthodoxies, it will call into question everything that finance ministries throughout the G10 have been claiming and doing.  As I wrote yesterday, I believe this election has the potential to signal a beginning of a significant change in the make-up of governments around the world.  Do not be surprised when there is significant support for 3rd party candidates in the US; when AfD wins an outright majority in a state election or two in Germany; and if Mexico throws the ruling PRI out of office.  As Neil Howe and William Strauss wrote in their tour de force, The Fourth Turning, this is the time when major upheavals occur.  Be prepared for more volatility in financial markets as these changes make their way into the system.  In other words, stay hedged!

Ok, back to the markets as they currently sit.  Yesterday’s strong US equity performance found limited follow-through around the world.  Asian indices were mostly slightly lower and European indices are mixed with the DAX (+0.2%) edging higher while the CAC (-0.25%) and FTSE 100 (-0.5%) are both under pressure.  As to US futures this morning, at this hour (7:30), they are ever so slightly softer, -0.1%.

In the bond market, Treasury yields edged lower yesterday amid a relatively quiet session and are a further 1bp softer this morning.  European sovereign yields are also a touch softer, somewhere between -2bps and -4bps, generally speaking, while JGB yields fell a further 5pbps overnight and are now down to 0.69%.  This is certainly a far cry from the idea of tighter Japanese policy, although the yen continues to strengthen.  Two noteworthy aspects in the Treasury market are that the 20yr auction yesterday went off without a hitch as the tail was actually negative (the highest yield was lower than the when-issued price) and dealers only took down 9.5% of the auction.  This is a far cry from the terrible 30-year auction we saw last week.  But the other thing that is not getting much press is the fact that the yield curve continues to reinvert with the 2yr-10yr spread back to -48bps this morning.  Recall, this had fallen as low as -15bps and looked like it was about to normalize just a few weeks ago.  Arguably, investors are telling us that the prognosis for future growth is declining although they are still uncertain as to when the Fed will begin cutting rates.

Oil prices, which have rallied for the past several sessions, are a touch softer this morning as the market has become confused to the key drivers.  Does OPEC+ and its production matter more than economic activity?  Are supplies tight or loose?  I expect that we are going to continue to see uncertainty and volatile price action until something clearer shows up.  As to the metals markets, gold and silver have both rallied this morning with gold creeping back toward that $2000/oz level, although not yet breaking through.  But base metals are mixed with very minor movement.  While equity investors remain convinced the soft landing is a given, the commodity space is far less certain.

Finally, the dollar remains under pressure as sliding Treasury yields weigh on the greenback.  Once again JPY (+055%) is the leading gainer in the G10 and remarkably, CNY (+0.35%) is leading the way in the EMG space.  What is quite interesting here is that the spot USDCNY rate in the market has fallen below the fixing rate for the first time since June.  You may recall that the spot rate had been hovering at the 2% band limit for quite a while.  This is another indication that the near-term outlook for the dollar remains lower.

On the data front, we get the Chicago Fed National Activity Index (exp 0.02) and Existing Home Sales (3.9M) this morning and then the FOMC Minutes at 2:00 this afternoon.  You may recall that the Statement in the beginning of the month was seen as hawkish, but the press conference was seen as dovish and they talked about how financial conditions had tightened and helped the Fed along.  But now, those conditions have eased again.  Also, we have heard from so many Fed speakers in the interim, it is hard to believe that whatever they said three weeks ago is newsworthy.

So, with more eyes on the clock ,as folks want to get away for the holiday and are worried about travel conditions, than market conditions, I suspect today, and tomorrow and Friday, will be very quiet indeed.

Good luck

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Could Cause Contraction

Posted on by 
A story that’s gained lots of traction
Is Jay will soon jump into action
By cutting the rates
They charge for short dates
Cause high real rates could cause contraction

In fact, this idea ‘s gone mainstream
And it’s now a favorite theme
But history shows
The ‘conomy grows
Despite real rates high with esteem

After a spate of slightly softer than expected data in the US, it is very clear the consensus in markets is that not only is the Fed finished raising rates, but that cuts are coming soon.  At this point, based on pricing on the CME for Fed funds futures, the Fed is going to cut rates by 100 basis points next year.  While I’m certainly no PhD economist (thank goodness!), this strikes me as a mistake.  Consider the following:

  1. If the economy really does go into recession in Q1 or Q2 of next year, where GDP turns negative and the Unemployment Rate rises close to 5.0%, it strikes me that the Fed is going to cut a lot more than 100bps.  In fact, the one thing we know is that Fed funds tend to decline much more rapidly than they rise as the Fed is usually responding late to some crisis.  So, a simple model can be created that shows 100bps of rate cuts is made up of a 20% probability of no movement at all; a 60% probability of 50bps of cuts next year as they try to tweak policy at the margin, and a 20% probability of 350bps of cuts as they respond to a recession and get aggressive.  Now, you can adjust those probabilities in any number of ways, but that seems reasonable to me.  However, that is not the market narrative.  Rather, the narrative is that the Fed is going to start to cut rates because policy is already overtight (real rates are positive) and they will want to get ahead of the curve.
  2. However, exactly why will the Fed need to cut, absent a full-blown recession?  Going back to 1982, these are the highest and lowest levels for real 10Yr yields, real Fed funds (defined as Fed funds – CPI) and Y/Y GDP each quarter:
 Real 10YrReal Fed fundsGDP Y/Y
Max7.60%8.30%9.60%
Min-0.35%-7.90%-2.20%

            Data: FRED database, calculations Fxpoet

So, we have seen real yields, both short- and long-term much higher and much lower than the current situation.  But the funny thing is, the relationship between GDP growth and real interest rates, whether 10Yr or overnight, is basically zero.  In fact, I ran the numbers and came up with an R2 of just 0.03 which tells me that there is no relationship of which to speak.  My point is just because real rates have risen to a positive level in the past year does not mean that the Fed has ‘overtightened’.  It just means that they have tightened policy trying to address what they still see as too high inflation.  It also does not indicate that because real yields have risen over the past quarters, that the economy is about to crash.  That’s not to say we are going to necessarily avoid recession, but the point is it will take much more than modestly higher real interest rates to push us over the edge.  At least that’s my view.

But for now, most markets are getting quite excited about the idea that peak interest rates are behind us and that the upcoming lower interest rates are going to support risk assets, especially equities, aggressively.  I feel a lot can go wrong with that model, but then I’m just an FX guy.

The Argentine people have spoken
As they want to fix what’s been broken
So, starting today
The new prez, Milei
Must change more than merely a token

A brief comment on this electoral outcome.  While Argentina’s economy is quite small on the global scale, I believe this is a harbinger of far more electoral shake-ups in 2024 and 2025.  We need only go back to 2015 when the Austrian presidential election was initially called for the complete outlier candidate, a non-politician as well as a right-wing firebrand, before being overturned by the courts there.  That story preceded the Brexit vote and then, of course, the election of Donald J Trump as US President in 2016.  People were very clearly tired of the political elite explaining why the masses needed to suffer while the elite got along just fine.  

The ensuing resistance by the entrenched politicians was fierce and so we saw Trump lose his reelection bid amidst great turmoil and then the election and collapse of Liz Truss in the UK.  But it appears that things have gotten worse in the broad populace’s collective mind, with inflation remaining stubbornly high, and perceptions of opportunity shrinking.  Combining those features with a growing distrust of media and government pronouncements after the Covid situation, where vaccines did not prove as efficacious as promised and, in fact, seemed to result in at least as many harms as benefits, and people are ready for a new look.

So, be prepared for some more non-traditional electoral winners next year.  Presidential elections are due in Taiwan, Mexico and the US with major regional elections throughout Germany, Canada, South Korea, India and the UK as well as the European Parliament.  Many people are quite pissed off at the incumbents around the world so look for more fragmentation and new faces.

This implies that much of how we consider the macroeconomic picture could well change.  And that means market volatility seems likely to increase further.  Just something to keep in mind, and an even more important reason to maintain hedges for major exposures, whether FX or interest rates.

Ok, it was easy to spend time on these issues as there is really nothing else going on.  Overnight, the only news was that the PBOC left their Loan Prime rates unchanged, as expected, so not really newsworthy.  Else, the biggest news over the weekend was arguably the Argentine elections.

It should not be surprising that market movement has been quite muted with the biggest equity move in Hong Kong (+1.85%) which is just a retracement of its recent woes.  Otherwise, Japanese markets fell somewhat (-0.6%) and the rest of APAC was very muted.  In Europe, there is a mix of gains and losses with nothing more than +/- 0.25%, so no real news and US futures are essentially unchanged at this hour (7:00).

Bond yields are, overall, a touch firmer this morning with Treasury and most European sovereign yields up 3bps.  But that is after another decline on Friday, and the 10yr remains quite close to its new home of 4.50%.  The ‘inflation is dead’ theme had a lot of proponents last week, but as we head into this, holiday shortened, week with limited new economic data, I suspect that things are going to be quiet without any new trends taking hold.  The market technicians explain that 4.33% and then 4.00% are the key yield supports.  So far, the first has held and I expect we will need to see much softer data to break it.

Oil prices are rebounding further this morning, up 1.5%, as there is talk that OPEC+ may be set to cut production even further with the price now below the level when they first initiated cuts in the summer.  There seems to be a disconnect between the official supply and demand data and the price, where the data would indicate prices should be higher.  One possible explanation has been that more Iranian oil has been reaching the market than officially allowed and so weighing on prices.  Alas, that is a very hard story to prove.  As to the metals markets, precious metals are softer this morning, but still retain the bulk of their recent gains while copper (+0.4%) is higher after Chinese demand indicators started to show strength.  

Finally, the dollar is starting to edge lower this morning as NY walks in the door after a very quiet overnight session.  USDJPY is the leader here, falling -0.8%, and we are seeing a large decline in USDCNY (-0.55%) as well.  Recently, there has been a distinct uptick in the number of pundits who are calling for a sharp decline in USDJPY.  Much is predicated on reading between the lines on Ueda-san’s pronouncements and expecting that QQE is finally going to end there.  Ironically, 10yr JGB yields are down to 0.74%, well below the highs seen at the beginning of the month and do not appear to be headed higher, at least for now.  To the extent that the Japanese MOF actually does want a stronger yen, something about which I am not at all certain, one must beware the idea that they could come in and intervene now, when they are jumping on the bandwagon rather than trying to stop a rush against them.  It would certainly be a lot more effective and would likely change a lot of opinions.  The one thing I have learned in my time in the markets is that when USDJPY starts to move lower, it can do so very quickly and for quite a long way.  

Away from those two currencies, both Aussie and Kiwi are firmer by about 0.6%, benefitting from strength in the renminbi as well as most commodity prices.  Not surprisingly, NOK (+0.5%) is rallying although it is a bit more surprising that CAD is essentially unchanged on the day.  Also remarkable is that CNY is the biggest mover in the EMG space, with most other currencies just barely changed on the day.

During this holiday week, there is very little data to be released with Existing Home Sales (exp 3.9M) tomorrow along with the FOMC Minutes and then Durable Goods (-3.2%, +0.1% ex transport) on Wednesday along with the Claims data.  Happily, it appears that the FOMC has taken this week off and will not be adding to their recent commentary.

Overall, the short-term trend appears to favor softness in interest rates leading to modest strength in risk assets and weakness in the dollar.  I am not yet convinced that is the long-term view, but for this week, I think that’s a fair bet.

Good luck

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More Fun Than Blondes

Posted on by 
In just the past week we have seen
That traders have changed their routine
They’re confident bonds
Have more fun than blondes
‘Cause rate cuts are what they now glean

Despite this, most central bank threads
Explain rate cuts ain’t in their heads
They all still maintain
Inflation’s not slain
And so now, they’re at loggerheads

There is only one story that continues to drive market activity lately, and that is bond yields.  They have become the best barometer of market sentiment we’ve seen in quite a while and the reaction function is quite clear; lower yields mean a soft landing, is coming and with it, central bank rate cuts to prevent a hard one.  While the US continues to lead the way, we are seeing yields decline around the world.  In essence, the bond markets worldwide have declared victory on behalf of the central banks.  In fact, as I look at my screen this morning, of the major economies in the world, only two, Mexico and South Africa, have seen 10yr yields climb today and that has been by 1.5bps and 0.5bps respectively.  In other words, virtually unchanged, while the rest of the world has seen declines of between 3bps and 7bps with even JGB yields lower by 5bps.

There are more and more adherents to the soft landing story as recent inflation readings have been declining steadily while economic activity is not slipping nearly as quickly.  Of course, this view is not universal as there remains a camp that points to underlying pieces of the economic puzzle like slowing bank lending growth or sliding manufacturing and are still looking for a more dramatic downturn in economic activity.  But generally, between the cheerleaders in finance ministries around the world and CNBC talking heads, all is right with the world.

Of course, if you are a central banker right now, all this positivity is working at cross purposes to your view that inflation is not actually dead and there is still further to go.  This is why we continue to hear that although progress has been made, it’s too early to take the victory lap.  We heard it from Cleveland Fed President Loretta Mester yesterday and from Austrian Central Bank chief and ECB Council Member Robert Holzmann this morning.  And we have been hearing it consistently for the past week, policy is somewhat restrictive, but we need to stay here until we are sure inflation is heading back to target.

Now, I am old enough to remember when the idea of tighter financial conditions doing the Fed’s job for them was a thing.  But in the month that has passed since that was first mooted, financial conditions are actually looser now than then.  The point is that the feedback loop between the data and the market response is now so dramatic, and occurring so rapidly, that the central bank reaction function is falling further behind the curve.  I have neither heard nor read a single thing in the past several days that implies there is a possibility the central banks are not done.  

But whether more rate hikes will do anything for inflation is no longer the issue, my sense is central banks want to make sure they are seen as in control.  I know things have been great lately with equities and bonds on fire and everybody’s 401Ks growing, but Jay doesn’t really care about your portfolio, and absent a complete collapse in economic activity in the next month, I would not be surprised by a December rate hike.  There is clearly no certainty on this, and the Fed funds futures market is currently pricing in just a 0.3% chance of it occurring.  I also know the Fed does not like to surprise markets, but I think the Fed fears the appearance of losing control more than anything else.  

However, until such time as they sound increasingly forceful, or the data starts to show inflation is not collapsing, it is hard to fight this move.  We have come a very long way in a very short period of time with respect to 10-year Treasury yields, a 60 basis point decline in slightly less than a month.  Be careful in assuming this will continue in a straight line.  As well, the fact that the yield curve’s inversion remains at -40bps is quite interesting.  Given the market is pricing 100bps of rate cuts by the end of 2024, I would have expected the front end of the curve to have fallen further in yield.

But that is where things stand as we get ready for another weekend and then, next week’s Thanksgiving holiday.  So, a quick tour of the overnight session shows that Chinese equities remain under pressure, especially in Hong Kong (-2.1%) as whatever they are doing over there is not solving their problems.  However, Japan is benefitting with modest gains and Europe is higher this morning across the board, about +0.8%.  As well, after a mixed day yesterday, US futures are pointing slightly higher, +0.2% or so at this hour (8:30).

We know the bond story so a look at commodities shows oil bouncing a bit, +1.3%, although it has been a horrific week and month for the black sticky stuff, down -15% in the past month.  Gold and silver, however, are huge beneficiaries of the decline in yields as they continue to rally and base metals are holding their own as well on the softer yield story.

Finally, it should be no surprise that the dollar remains under pressure, down 0.2% broadly (the DXY).  In the G10, JPY (+0.85%) is the leader followed by AUD (+0.5%) but all of them are firmer.  While there is a little more divergence in the EMG bloc, the broad trend remains for a softer dollar and as long as US yields remain under pressure, the dollar is likely to do so as well.  The one place I would watch carefully is the yen, as there is a growing belief it is set to rebound sharply.  On the plus side is the fact that US yields are falling, and the rate narrative is changing rapidly.  But remember, Japanese yields are also declining, and their recent GDP data was terrible, -2.1% in Q3, so the idea that the BOJ is going to tighten policy soon seems shaky at best.  There are many technical support levels on the way down, but do not be surprised of a test of 142.00 in the coming weeks if the current zeitgeist continues.

On the data front, Housing Starts (1.372M) and Building Permits (1.487M) were both released this morning pretty much on target and put paid to the idea that the housing market is collapsing. For the rest of the day, we have 5 more Fed speakers, but I doubt we hear anything new.  One other thing to remember is that Sunday, Argentina goes to the polls and the chances for the upstart candidate, Javier Milei, seem pretty good as the people there are fed up with the current government.  That could have some repercussions both financially and politically around the world, especially the latter, as it would be another step away from the current ruling class.  The point is, I do not believe that everything is better, and while right now things look good, there is more volatility in store.  Be careful and stay hedged, it is your best protection.

Good luck and good weekend

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Markets No Longer Have Fear

Posted on by 
The CPI data made clear
That markets no longer have fear
But Jay and his team
Will still push the theme
That cuts in Fed funds just ain’t near

As such markets have been persuaded
It’s time for the Fed to be faded
The bulls are on top
And they just won’t stop
Til new record highs have been traded

By now, you are all well aware that yesterday’s CPI data came in a bit softer than the forecasts with the headline printing at 3.2% Y/Y while the core printed at 4.0% Y/Y.  Both of these were 0.1% lower which doesn’t seem to be that big a difference.  But the bulls are stampeding on the idea that if you look at the recent trend, the annualized rate for the past 6 months is lower still (3.0% and 3.1% respectively) and the implication is that inflation is dead and the Fed has achieved the impossible, reducing inflation without causing a recession.  And maybe they have, but boy, that is a lot to take away from a single data point that printed a smidge lower than expectations.

Two weeks ago, in the wake of the last FOMC meeting, I wrote (Bulls’ Fondest Dreams) that the Fed changed their tune and despite all the pushback we have received from Fed speakers in the interim, they definitely saw the end of the hiking path coming into view.  Yesterday’s data seemed to confirm this view, at least in the markets’ eyes.  As such, we saw a massive rally in both stocks and bonds, with 10-year yields falling 20 basis points at one point in the day before closing lower by about 17bps.  They are 2bps higher this morning on the bounce.  Interestingly, European sovereign yields also fell quite sharply despite the lack of local news as the price action once again proved that the 10yr Treasury yield is the only bond price that really matters in the world.

So, to me the question is now, is this view correct?  Has the Fed actually threaded the needle and successfully reduced inflationary pressures without causing a meaningful economic slowdown?  If so, Chairman Powell will rightly be hailed as a brilliant central banker, even if there was some luck involved.  How can we know, and more importantly, when will we be certain this is the case?

I think it is important to try to separate the markets and the economy as the two are really quite different.  The economy is where we all live.  From an individual perspective, I would contend it is a combination of one’s employment situation(and whether there is concern over losing one’s job or finding a new one), the true cost of living, meaning the ability to afford the mortgage/rent as well as put food on the table, and then to see if there is any additional money left to either save or spend on desires rather than necessities.  It seems abundantly clear that from this perspective, there is a large segment of the population that doesn’t feel great about things.  This was made clear in an FT survey that showed just 14% of those surveyed thought things had gotten better economically under the Biden Administration’s policies.

However, if this poet has learned nothing else in his time trading in, and observing, financial markets, it is that policymakers do not care one whit about those issues.  Despite periodic attempts to seem down-to-earth, the reality is they all exist within a policy bubble with no concerns about the rent or their next meal.  In this bubble exist only numbers like yesterday’s CPI or today’s Retail Sales (exp -0.3% headline, 0.0% ex autos).  GDP, to them, is not a measure of people’s confidence or belief in the state of the current world, it is a policy variable that they are trying to manage or manipulate so they can make positive pronouncements.

There is obviously quite a gulf between those two views of the world and the markets are the connection, trying to interpret the reality on the ground through the lens of the data.  Well, the policymakers must be thrilled today because the extraordinary bullishness that is now evident across all risk markets, in their minds, means that their jobs are secure.  When things are going well, reelection/reappointment are the expected outcomes.  However, that FT survey was clearly a warning shot across the bow of their Good Ship Lollipop that everything was going to be great going forward.

So, what’s it going to be?  As I wrote after the FOMC meeting, I believe the market is prepped to rally through the rest of the year.  After yesterday’s data, that seems even clearer.  But do not forget that one of the key rationales for the Fed’s change of heart was that the market was doing the Fed’s work for them, tightening policy by raising rates and watching risk assets drift lower, thus tightening financial conditions.  Let me tell you, financial conditions loosened a lot yesterday, and if this rally continues, you can be certain that Powell and friends will grow more concerned about a rebound in inflation.  The market has completely removed any probability of a December rate hike, or any further rate hikes by the Fed as of yesterday with the first cut now priced for May 2024.  At this stage, it seems probable that the October PCE data will be on the soft side so much will depend on the next NFP and CPI readings, both of which are released before the next FOMC meeting.

And there is one more thing that must be remembered when it comes to the bond market.  The US is still going to issue an enormous amount of debt going forward between refinancing ($8.3 trillion though 2024) the current debt and the new $2 trillion budget deficit that needs to be funded for next year.  Can bonds continue to rally in the face of that much supply?  Maybe they can, but it would seem to require a reengagement of foreign buyers rather than relying entirely on domestic savers.  Either that or the Fed will need to end QT and possibly even restart QE.  In the latter case, inflation would almost certainly become a major issue again.  The point is, while everyone is feeling great this morning, there are still numerous perils to be navigated in order to maintain economic growth with a low inflation regime.  I hope Jay and all the central bankers are up to the task, but a little skepticism seems in order.

Ok, the overnight session can be summed up in one word: BUY!  Equity markets everywhere rallied with strong gains in Asia (Hang Seng +3.9%) and Europe, after rallying yesterday, continuing higher by nearly 1% this morning.  US futures are also all green this morning, generally +0.5% at this hour (7:30).

Bond markets have mostly held onto yesterday’s impressive gains with some trading activity, but movements all within a basis point or two from yesterday’s close.  The exception was Asian government bond markets, where prices rallied sharply, and yields tumbled there as well, following the US lead.

Metals prices are ripping higher again this morning, with gold, silver, and copper all up nicely after strong gains yesterday.  The outlier here is oil, which is a touch lower (-0.4%) this morning after a very lackluster session yesterday.  Now, in fairness, it has been creeping higher for the past several sessions, but compared to other markets, oil is remarkably quiet right now.

Finally, the dollar got smoked yesterday, with the euro rallying 1.5% and similar moves across the other European currencies.  Meanwhile, AUD rallied more than 2% yesterday as the combination of rocketing metals prices and a broadly weaker dollar were just the ticket for the currency.  In the EMG bloc, ZAR (+3.0%) and MXN (+1.5%) were the big winners yesterday although, interestingly, most of the APAC currencies had much more muted runs, on the order of 0.5%-1.0% gains.  This morning, price activity is much more subdued as FX traders are trying to get their bearings again.  It was, however, a 3-sigma day, a rare occurrence.

On the data front, as well as Retail Sales, we also see PPI (exp 2.2% headline, 2.7% ex food & energy) and the Empire Manufacturing Survey (-2.8) along with EIA oil information where inventory builds are forecast.  There is only one Fed speaker, vice chairman of supervision Michael Barr, and I don’t expect he will be able to sway any views today.

For now, the die is cast, and the bulls are in the ascendancy.  We will need to see some very big changes in the data trajectory for the current momentum to stall, and quite frankly, I don’t see what that will be for now.  So, go with the flow here, higher stocks, lower yields and a softer dollar seem to be the trend for now.  There will be some trading back and forth, but you can’t fight City Hall.

Good luck

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