Ending QT

Posted on January 8, 2024 by fxpoet

The lady from Dallas explained
The balance sheet might be constrained
So, ending QT
Is likely to be
The way the Fed’s goals are attained

However, investors ain’t sure
That ending QT is the cure
So, worries abound
As traders have found
Most stocks have now lost their allure

Over the weekend, Dallas Fed President Lorie Logan, whose previous role was head of markets at the NY Fed and so knows a thing or two about the monetary plumbing, explained in a speech that QT, at its current pace, is likely going to be too restrictive going forward. While she threw in the obligatory line about the idea the Fed may still need to raise the Fed funds rate if inflation remains too robust, I would contend that this is another sign the Fed is coming to the end of its tightening regime. She explained that the swift decline in the Reverse Repo (RRP) facility indicated there may be a significant decline in liquidity in markets and that could have a detrimental impact on ~~equity prices~~ the economy’s future path and derail the widely assumed soft-landing scenario.

For some context, the RRP facility peaked almost exactly one year ago, touching about $2.55 trillion as the Fed was paying more on excess reserves than was available in short-term paper and Treasury bills. But as the government has flooded the market with T-bills of late, and there is no indication that pace is going to slow down, the yield on bills rose above the IOER rate the Fed was paying. As such, money market funds have pushed funds from the RRP into purchasing bills and the RRP facility now has “just” $694 billion as of Friday. A look at the chart below from the FRED database of the St Louis Fed shows the sharp downward trajectory of the facility’s balances. But also notice that prior to March 2021, this facility basically was at $0 for its entire history. My point is that this facility does not have a long history of supporting market activities or liquidity, rather it is a recent construct designed to help smooth out temporary fluctuations. It’s just that the concept of temporary here seems akin to the Fed’s concept of transitory when it comes to inflation.

At any rate, the FOMC Minutes also mentioned the idea that QT would likely need to slow down, and the committee needed to discuss the proper timing of these things. Logan’s comments were exactly in this vein as the Fed seem like they are working very hard to prepare market participants for the beginning of an easing cycle. It’s kind of funny that throughout November and December, the Fed seemed a bit concerned that markets were overexuberant, but after a modest equity market sell-off to start the year, much of which can probably be put down to profit-taking on a tax advantaged* basis, they seem suddenly concerned that things are falling apart.

Logan’s comments were in the wake of Friday’s data which showed NFP stronger than expected, although another month of downward revisions for previous readings, and showed wages gaining a bit more than expected. The initial move here was that further tightening was on the way, or certainly that easing was delayed, but then the ISM Services index was released at 10:00am and it was much worse than expected, 50.6, with the Employment sub-index printing at a horrible 43.7, its lowest level excluding the Covid months, and indicative that perhaps the job market is not quite so robust. This helped unwind the tightening discussion and Friday’s markets ultimately closed little changed.

Which brings us to this morning, where the most noteworthy price action is in the commodity space with oil (-2.8%) sharply lower after Saudi Arabia cut its pricing indicating that demand is slow, and gold (-1.25%) falling sharply although a rationale there is far harder to find given the dollar is essentially unchanged on the day and it certainly doesn’t appear that peace is breaking out in either Israel/Gaza or in Ukraine.

While there has been a bit of data released from Europe, none of it was substantially different from expectations and it showed that the status quo remains there, overall, a weak Eurozone economy with prices still on the sticky side. As well, there have been no speakers this morning which just leaves us all unsure of the next big thing.

Now, in fairness, we do have the next big data point coming on Thursday, CPI in the US, which I am assured by so many analysts is THE critical data point. I was also confident that NFP was critical, so perhaps CPI will be less exciting than forecast. In the meantime, a look at the rest of the overnight session shows that Japan was on holiday so there was no market activity, but Chinese shares have continued their weak ways, falling more than -1.3% across all the indices there. It seems to me that despite some very real efforts to inculcate fear of China by certain politicians, President Xi has an awful lot of domestic issues to address. European shares, though, are little changed with a few very modest gainers (DAX +0.15%) and a few very modest decliners (FTSE 100 -0.2%) and everything else in between. US futures are softer this morning as the weekend story regarding Boeing’s 737 Max being grounded is weighing on the stock and the market as a whole.

In the bond market, Treasuries are unchanged on the day while European sovereigns are all seeing yields climb between 4bps and 5bps. This move seems like a catch-up to Friday’s US price action, which if you remember saw a sharp decline in yields early and a rebound later on. Ultimately, this space will continue to be driven by the central banks with the Fed funds futures market still pricing in a > 60% probability of a 25bp cut in March with Europe seen likely to follow shortly thereafter.

Having already touched on commodities, a look at the dollar shows that while the euro, pound and yen are all little changed, there is a bit more movement in the dollar’s favor amongst some less liquid currencies with AUD (-0.4%), NOK (-0.85% on weak oil prices) and KRW (-0.4%) leading the way. I continue to see the FX markets as an afterthought to the broad economic picture right now but have not changed my view that if the Fed does lead the way in easing policy, the dollar is likely to slide.

On the data front, here is what this week brings:

Today	Consumer Credit	$9B
Tuesday	NFIB Small Biz Optimism	91.0
	Trade Balance	-$65.0B
Thursday	Initial Claims	210K
	Continuing Claims	1853K
	CPI	0.2% (3.2% Y/Y)
	-ex food & energy	0.2% (3.8% Y/Y)
Friday	PPI	0.1% (1.3% Y/Y)
	-ex food & energy	0.2% (1.9% y/Y)

Source: tradingeconomics.com

As well, we do hear from several Fed speakers this week starting with Bostic today and then Williams and Kashkari as the week progresses. At this stage, I expect that we are likely to see less volatility as my guess is most profit adjustments have been made and all eyes are turned to CPI on Thursday. Until then, it is likely to be a dull week (famous last words!)

Good luck

Adf

*This tax advantage is simply that taxes will not be due until April 2025, so perhaps tax deferred is a better description.

Quite Frail

Posted on January 5, 2024 by fxpoet

While everyone’s waiting to see
How high or low payrolls might be
The news from elsewhere
Is starting to wear
Quite thin, look at China’s Zhongzhi

This bankruptcy sounds the alarm
That others there might come to harm
The soft-landing tale
Which still is quite frail
Has started to lose its quaint charm

Before we start on the payroll report, I think it is important to mention a significant issue that was revealed last night in China, where Zhongzhi, one of the largest non-bank financial and investment companies on the mainland, filed for bankruptcy and liquidation. It has been missing both interest and principal payments for the past several months and it simply became too great a problem to ignore any longer. The data released indicates that the company had ~$31 billion more in liabilities than assets and has become one of the largest bankruptcies in China’s history.

The company was a major player in the property market there, although its main business was high yielding investment products, essentially structured notes, where much of the property backed collateral has fallen dramatically in value and where cash flows that had underpinned the notes have now ceased amid the property collapse. This is hardly an advertisement for the Chinese economy and another sign that things there remain in a downtrend. While the renminbi is marginally firmer this morning, up 0.2%, that is a consequence of the PBOC establishing the CFETS fixing at a much stronger than expected level in their effort to prevent substantial weakness in the currency.

The upshot is that the Chinese economy remains in difficult straits, and the government’s reluctance to increase fiscal support is being felt everywhere. (On the other hand, the PBOC has added $600 billion in liquidity to the economy in the past week.) Ongoing weakness in Europe is another problem for Chinese exporters and the ongoing disagreements and tariff wars with the US simply add additional pressure to President Xi. Next Saturday the first big election of 2024 will be held, in Taiwan, and if the incumbent party retains control, currently the betting favorite, Xi may find himself with quite a few problems to address this year. A weak economy, rising geopolitical tensions globally and a rejection of his entreaties to the people of Taiwan is a bad look for a megalomaniacal dictator like Xi. Just sayin’.

OK, let’s turn to this morning’s big story, the NFP report. Here are the analyst consensus estimates according to tradingeconomics.com:

Nonfarm Payrolls	170K
Private Payrolls	130K
Manufacturing Payrolls	5K
Unemployment Rate	3.8%
Average Hourly Earnings	0.3% (3.9% Y/Y)
Average Weekly Hours	34.4
Participation Rate	62.7%
ISM Services	52.6
Factory Orders	2.1%

Now, yesterday we saw two other pieces of employment data, the ADP (164K and much higher than expected) and Initial Claims (202K and much lower than expected). These numbers have many in the market looking for a strong print although the correlation between ADP and NFP has been underwhelming for quite a while. While we can discuss the merits of the estimates and the overall strength of the economy, I think we are better served, this morning, to focus on the potential impacts of a given number and how that has been evolving so far this week/year.

This morning, the 10-year yield is up to 4.04%, some 25bps above the lows touched post-Christmas, and starting to indicate that some people are having second thoughts on the idea of the Fed aggressively cutting rates this year. As an example, while I never believed there to be a chance of a rate cut at the end of January, the market was pricing a 17.5% chance of that just a week ago. This morning the probability is down to 4.7%. As well, just last week the market was pricing in 6 rate cuts in 2024. That is now down to 5 cuts and fading. One of the big stories around this morning is that someone has put on a very large option position expiring later today that the 10-year yield will be above 4.15%. To profit, this trade will require one of the largest yield moves seen in months.

The point is that the nirvana belief set that had been driving markets since the beginning of November is clearly under a significant amount of pressure here. After all, the NASDAQ has had 5 consecutive negative closes, bond yields, as mentioned, have rallied sharply and are breaking through short-term technical resistance, the dollar is rallying, and the bulls are feeling quite unloved.

Is this the end of the bull story? Frankly I don’t believe that is the case. However, risk assets got a bit overexuberant during November and December and have come a long way in a short time. It is not surprising to see a retracement of prices to help unwind some of the froth. Ultimately, I believe the question that matters in the medium and long term is the state of the economy and whether the recent growth trajectory will continue, or if we have peaked for now.

One of the things that has me concerned in the medium term is the fact that the government continues to run a massive fiscal deficit despite what appears to be a reasonably strong economy. Recall, Keynes instructed governments to spend during recession, but tighten their belts during good times. However, the new mantra is far more in line with Modern Monetary Theory, which is spend as much as you can at all times.

A quick thought experiment regarding the underlying economy might look like this: GDP = $27 trillion, Federal spending = $10 trillion, Federal deficit = $1.7 trillion. What if the government didn’t run a deficit, but was neutral? Removing that much stimulus from the economy would have a significant negative impact on the US economy’s growth trajectory, which is the reason no politician wants to do that. But the question at hand is how healthy is the economy on its own? And are growth prospects there really that substantial? One of the keys to the recent employment picture is that government jobs continue to grow rapidly (look at the gap between NFP and private payrolls). As long as the US government can continue to borrow money cheaply to fund its profligate ways, it is completely realistic to expect the economy to continue to grow. However, the reason the bond market story is so important is that the bond market is the place where it will become clear if this is possible. If Treasury yields continue their recent climb, the pressure on the economy will increase, and the pressure from the government on the Fed to support the bond market will increase. Forget ending QT. If the Fed were to find itself in a place where they needed to restart QE to support the bond market, that would be an incredibly important signal that inflation was going to accelerate again, and likely commodity prices would follow. That would also be a very negative sign for the dollar. So, lower bonds, lower dollar, higher commodities and likely a nominal rise in equities, at least initially. My point is there is much about which we need be concerned and wary.

In the quickest of recaps possible, equities around the world have mostly been under pressure with only Japan managing to rally but weakness in China and across all of Europe. The same is true with US futures, all in the red this morning by about -0.3%.

Bond yields are also rising around the world (except in Japan) with gains on the order of 6bps-8bps across the continent, similar to what we saw in Australia overnight.

Oil prices are rebounding this morning, up 1.3%, despite much larger than expected inventory builds shown in yesterday’s IEA data, but the metals markets are continuing under pressure for now with the base metals weak and gold edging lower.

And finally, the dollar is continuing its rebound led by USDJPY, where the yen is down a further 0.4% and back above 145 for the first time since early December. In the G10 space, I would say the movement has been about -0.3% overall, but in the EMG space, things are a bit more active with average declines here of about -0.7% across the three main geographic blocs.

That’s really it. Now we just wait for the payroll report and later this morning the ISM Services number, and then we get to hear from Tom Barkin again, but it would be shocking if his view changed from just two days ago. For some reason, I have a feeling the payroll data will fall short this morning, but that’s just a feeling.

Good luck and good weekend

Adf

Dragged Through the Mud

Posted on January 3, 2024 by fxpoet

The year started out with a thud
As equity markets saw blood
The bond market fell
And oil’s death knell
Was sounded, whilst dragged through the mud

The question we now must address
Is, are markets set to regress?
Or, is this a blip
O’er which we can skip
Without adding too much new stress?

Has the narrative already changed? That seems to be the question we really need to ask after just one day of trading in 2024. It seems hard to believe that the macroeconomic fundamentals have changed very much, especially since we have not gotten any substantial data yet. While ISM Manufacturing (exp 47.1) and JOLTS Job Openings (8.85M) are due later this morning, it beggar’s belief that the market is anticipating much there. Sure, we get the payroll report on Friday, but given the goldilocks, soft-landing scenario had seemed to be the prevailing theory, have we actually seen anything that would change that view?

Of course, it is possible that market participants are fearful that the FOMC Minutes, which are released at 2:00 this afternoon are not going to reconfirm their broadly dovish views. You may recall that at the December FOMC meeting, Chairman Powell did nothing to disabuse the markets of the idea that the Fed had not only finished tightening, but that it was getting set to ease. From that point, the Fed funds futures market has priced in a total of six rate cuts for 2024, twice the number the median dot plot numbers showed and a pretty dramatic easing, especially if the economy does not fall into recession.

There is, of course, another possible rationale for yesterday’s weak start in risk assets; they were wildly overbought. Since that Fed meeting in the middle of December, stocks had rallied sharply (S&P 500 +3.4% at its peak), 10-year yields fell 40bps at their trough and the dollar, as measured by the DXY, had fallen more than 2%. The peak (trough) was seen immediately after Christmas, and we have been drifting back since then. In fact, I think it is fair to say that markets got a bit exuberant in the wake of the FOMC meeting.

But as we get back to fully staffed trading desks and investment managers are back from their holiday breaks, I suspect that price action is going to moderate a bit while volumes improve. As I tried to make clear yesterday, I believe that the recent uptrend in risk assets will continue broadly until we see enough data to change opinions. There remains a pretty large group of analysts who are in the “inflation is going to 1%” camp and that will allow (force?) the Fed to cut rates more aggressively to prevent real interest rates from becoming too restrictive. As that is a pleasing narrative, and one that the current administration would really like to see evolve, I expect that we will hear a lot about that for a while. And maybe that is what will come to pass.

However, my suspicions and fears are that 2024 will be less idyllic than those goldilocks scenarios that are being painted by the soft-landing crowd. I find it difficult to believe that amongst all the potential big picture problems, including escalation of the Middle East war, the Ukraine war, China’s recent threats about reunification of Taiwan, and the more than 40 elections that are due this year, culminating in the US election, there won’t be at least a few major hiccups. In fact, the ongoing unhappiness in the US electorate is likely to be one of the biggest issues driving what I believe will be risk aversion before the year ends. But that has not yet manifested itself, so we are likely to have interesting times ahead.

In the meantime, let’s look at the overnight price action. After the weak US equity performance, APAC markets mostly fell, with only Japan (Nikkei -0.2%) really holding in well. European bourses this morning are all lower, on the order of -1.0%, with the CAC (-1.5%) really suffering and US futures all in the red, led by the NASDAQ (-0.7%) although the others are down about -0.35% at this hour (7:45). Clearly, there has been no joy yet.

As to the bond market, this morning has seen Treasury yields back up a further 4bps and they are now at 3.97%, well off the lows seen post-Christmas. European bond markets have seen less aggressive rebounds in yields as the economic picture on the continent remains more dire than here in the US. Arguably, the ECB has a much tougher job than the Fed right now as the inflation data in Europe remains higher than in the US while economic activity is clearly slowing much more rapidly. (I guess if they had pumped as much fiscal stimulus into their economy as we did into ours, they wouldn’t be in this situation. Of course, the debt situation might be worse…). Ultimately, however, I expect that the lack of growth is going to dominate the mindset in Europe and that Madame Lagarde will be cutting rates as soon as she can. One last thing, Japan. Remember all the stories in December about how the BOJ was getting set to normalize policy (i.e., return rates to positive territory) and that Japanese investors would be repatriating money soon? Well, this morning 10-year JGB yields are at 0.60%, far below the 1.00% former YCC cap and the new reference rate and showing no signs of doing anything unusual.

Turning to the oil market, while it is rebounding this morning, +0.8%, it has been under significant pressure lately despite what appears to be a serious increase in the military posture in the Red Sea amid Houthi rebel attacks on ships and the US Navy responding more aggressively. In fact, Maersk, the largest shipping company in the world, has once again indicated it will not transit the Red Sea, an outcome that can only negatively impact the cost basis for shipping, and ultimately push upwards on inflation. This is an area where we need to keep a close eye for new developments. However, this morning the metals markets are under pressure as gold (-0.65%) is giving up some of its recent gains, although remains well above the $2000 level. But we are seeing weakness in the base metals as well, with both copper and aluminum under pressure this morning.

Perhaps a key driver of the metals markets has been the fact that the dollar has continued its rebound with the DXY higher by 0.3% this morning, having rallied 1.5% from its recent post-Christmas nadir. This has been a broad-based dollar rally with gains against both G10 and EMG currencies as it seems to be a dollar story. The best I can figure is that there is concern/anticipation that the Minutes are going to sound more hawkish than people remember the meeting and press conference.

On the data front, we see the following:

Today	ISM Manufacturing	47.1
	ISM Prices Paid	47.5
	ISM Employment	46.1
	JOLTS Jobs Openings	8.85M
Thursday	ADP Employment	115K
	Initial Claims	216K
	Continuing Claims	1883K
Friday	Nonfarm Payrolls	168K
	Private Payrolls	130K
	Manufacturing Payrolls	5K
	Unemployment Rate	3.8%
	Average Hourly Earnings	0.3% (3.9% Y/Y)
	Average Weekly Hours	34.4
	Participation Rate	62.7%
	ISM Serv ices	52.6
	Factory Orders	2.1%

Source: Tradingeconomics.com

Interestingly, only Richmond’s Thomas Barkin is scheduled to speak this week, first this morning and then on Friday afternoon as well.

Absent a new escalation in the Middle East, though, I would look for a little more profit-taking ahead of the payroll data. However, I continue to believe the market is going to push for the bullish framework for a few months at least which means equities will rally, yields will slide, and the dollar will fall as well.

Good luck

Adf

The New Allegory

Posted on December 11, 2023 by fxpoet

On Friday, the data surprised

With job growth more than advertised

So, bonds took a bath

And stocks strode a path

Where growth is what’s now emphasized



But what of the soft landing story?

Will rate cuts now be dilatory?

If Jay just stands pat

Will stocks all go splat?

Or is this the new allegory?

Well, this poet was clearly wrong-footed by Friday’s employment report where not only were non-farm payrolls stronger than anticipated at 199K, but hours worked rose and the Unemployment Rate fell 2 ticks to 3.7%. While revisions to previous reports were lower, as they have been all year, the report did not point to an imminent slowing of the economy nor a recession in the near-term. Arguably, the soft-landing crowd made out best, as equity markets, which initially plunged on the report following Treasury prices, rebounded as investors decided that growth is a better outcome than not. Yields jumped higher, as would be expected, rising 8bps in the US with larger gains throughout Europe before they went home for the weekend. And finally, the dollar flexed its muscles again, rallying universally with gains against 9 of the G10 currencies, averaging 0.4% (only CAD (+0.1%) managed to hold its own) and against most of the EMG bloc with a notable decline by ZAR (-1.1%), although MXN (+0.6%) bucked the trend.

Does this mean the soft landing is coming? As we start the last real data intensive week of 2023, it remains the favored narrative, but is by no means assured. After all, before the end of this week we will have seen the latest CPI reading in the US (exp 3.1% headline, 4.0% core) and we will have heard from the FOMC, ECB and BOE as well as several smaller central banks like the Norgesbank and the SNB. And let us not forget that the BOJ meets next Monday. So, there is plenty of new, important information that is coming soon and will almost certainly drive potential narrative changes.

Perhaps an important part of the discussion is to define what we mean by a soft landing, or at least what the ‘market’ means by the concept. My best understanding is as follows: GDP slides to 1% or so, but never goes negative. Unemployment may edge higher than 4.0%, but only just, with a cap at the 4.2% or 4.3% area, and inflation, as measured by Core PCE finds a home between 2.0% and 2.5%. This result, measured inflation falling back close to target while the growth and employment story just wobbled a bit, would be nirvana for Powell and friends.

How likely is this outcome? Ultimately, history is not on their side as arguably the only time the Fed ‘engineered’ a soft landing was in 1995, and on an analogous basis they had already started cutting rates by this time in the cycle. The fact that we are still discussing higher for longer implies that there is much more pain likely to come than the optimists believe. We have already seen the first signs of trouble as the number of bankruptcies soar and stories about non-investment grade companies needing to refinance their debt at much higher interest rates than the previous round fill the news. Certainly, Friday’s employment data is encouraging for the economic situation, but the chink in the armor was the wage data which showed more resilience (+0.4%) than expected. Given the Fed’s focus on wages and their impact on inflation, the fact that wage growth remains well above the levels the Fed deems appropriate to meet their inflation target is not a sign that policy ease is coming soon.

And ultimately, I believe that is the critical feature here. The economy has held in remarkably well considering the pace and size of the interest rate changes we have already seen. The big unknown is how much of that interest rate change has really been felt by the economy. Obviously, the housing market has felt the impact, and to some extent the auto industry, but otherwise, it is not as clear. Do not be surprised if this period of slow economic activity extends for a much longer time than in the past as the drip of companies that find themselves unable to refinance at affordable rates slowly grows. By 2025, about $1 trillion of corporate debt that was issued at much lower interest rates will need to be refinanced. I’m not worried about Apple refinancing their debt, but all the high-yield debt that was snapped up with a 4% or 5% handle during the period of ZIRP will now be at 10% or so and it is an open question if those business models will be functional with financing that expensive.

So, perhaps, the story will be as follows: economic activity is going to muddle along at low rates for an extended period, another 2 or 3 quarters, until such time as the debt ‘time-bomb’ explodes with refinancing rates high enough to force many more bankruptcies and start a more aggressive recessionary cycle with layoffs leading to rapidly rising Unemployment rates and economic activity falling more sharply. In this timeline, we are talking about the recession becoming clear in Q3 of 2024, a time when most of that $1 trillion of corporate debt will be current. While interest rates will certainly be slashed at some point, this does not bode well for risk assets in the second half of 2024. For now, though, it certainly seems like the current narrative is going to continue.

There’s no urgency

To change policy quite yet

But…some day we will

A quick story about the BOJ which last night pushed back firmly against the growing narrative that they were about to start normalizing interest rate policy with a rate hike in either December or January. Instead, several stories were released that described the recent decline in both GDP and inflation as critical and the fact that they still don’t have enough information with respect to wages in Japan, given the big spring wage negotiation has not yet happened, to make a decision. In other words, the BOJ was successful at convincing markets to behave as the BOJ wants, not as the rest of the world wants. The upshot was that the yen weakened sharply (-0.9%) while the Nikkei rose 1.5% and JGB yields were unchanged. The BOJ pivot remains one of the biggest themes in the macro community, mostly because it is seen as the place where the largest profits can be made by traders. But my experience (4 years working for a Japanese bank) helps inform my view that whatever they do will take MUCH longer to happen than the optimists believe.

Ok, let’s try a quick trip around markets here for today. Aside from Japan, most of Asia had a good equity session with Hong Kong (-0.8%) the only real laggard. Remember, a key story there remains the Chinese property sector as many of those firms are listed in HK. Meanwhile, European bourses are mixed although movements haven’t been very large in either direction. The worst situation is the UK (FTSE 100 -0.5%), while we are seeing some gains in the CAC and DAX, albeit small gains. Finally, US futures are pointing a bit lower, -0.2%, at this hour (7:45).

In the bond market, after Friday’s dramatic price action, Treasury yields are continuing to rise, up 5bps this morning, although European sovereign yields are little changed on the day, with the bulk of them slipping about 1bp. Given most saw quite large moves on Friday, and given the imminent policy decisions by the big 3 central banks, I suspect traders are going to be quiet for now.

Oil prices (-0.3%) are slipping slightly this morning but are mostly consolidating Friday’s gains. On the metals front, though, everything is red with gold, silver, copper and aluminum all under pressure. Again, this is the one market that has been pricing a recession consistently for the past several months while certainly equity markets have a completely different view.

Finally, the dollar is continuing to rebound on the strength of rising Treasury yields. While the euro is little changed on the day, the yen is driving price action in Asia with weakness also seen in CNY, KRW and TWD. As well, ZAR (-0.8%) continues to suffer on weaker commodity pricing and both MXN and BRL are under pressure leading the LATAM bloc lower. At this point, I would say the FX market has more faith in Powell’s higher for longer mantra than some other markets.

As mentioned, there is a lot of data this week:

Today	NY Fed Inflation Expectations	3.8%
Tuesday	NFIB Small Biz Optimism	90.9
	CPI	0.0% (3.1% Y/Y)
	-ex food & energy	0.3% (4.0% Y/Y)
Wednesday	PPI	0.1% (1.0% Y/Y)
	-ex food & energy	0.2% (2.3% Y/Y)
	FOMC Rate Decision	5.5% (unchanged)
Thursday	ECB Rate Decision	4.5% (unchanged)
	BOE Rate Decision	5.25% (unchanged)
	Retail Sales	-0.1%
	-ex autos	-0.1%
	Initial Claims	221K
	Continuing Claims	1891K
Friday	Empire State Manufacturing	2.0
	IP	0.3%
	Capacity Utilization	79.2%
	Flash PMI Manufacturing	49.1
	Flash PMI Services	50.5

Source tradingeconomics.com

Thursday also has the Norges Bank and SNB, both of whom are expected to leave rates on hold. For today, it strikes me that the discussion will continue as pundits try to anticipate what the FOMC statement will say and how Powell sounds in the press conference. As such, it is hard to get excited that there is going to be a big move in either direction. With all that in mind, my overall read on the economy is that while we may muddle along in the US for a while yet, it will be better than many other places in the world, notably the EU, the UK and China, and so the dollar is likely to hold up far better than most expect…at least until Powell changes his tune.

Good luck

Adf

Jay Powell’s Dream

Posted on December 8, 2023 by fxpoet

As markets await the release

Of Payrolls, all things are at peace

But once it’s revealed

We need watch the yield

In 10-years lest it should decrease



While Goldilocks is still the meme

And certainly, Jay Powell’s dream

The data’s beginning

To show growth is thinning

More quickly both down and upstream

So, here’s the scoop. Today is payrolls day and that is the only thing that anybody cares about right now, ahead of the release, and it will be the topic du jour by all the talking heads for the rest of the day. As of 7:00am, here are the latest consensus forecasts according to tradingeconomics.com:

Nonfarm Payrolls	180K
Private Payrolls	153K
Manufacturing Payrolls	30K
Unemployment Rate	3.9%
Average Hourly Earnings	0.3% (4.0% Y/Y)
Average Weekly Hours	34.3
Participation Rate	62.7%

Now, looking at a chart of the past year’s releases, the numbers seem to show a very gradual decline, albeit hardly in a regular manner.

But let’s take a look at some underlying data that may help us understand the bigger picture a bit better. First off, one of the things that draws a great deal of criticism is the birth/death model that the BLS uses to estimate the number of new companies that start up, hiring people, compared to the number of companies that close with the resulting job losses. A key reason that every month this year has seen the data revised lower is because that portion of their data continues to be revised lower. Historically, the birth/death model is at its worst during an inflection point, when the economy is either entering or exiting a recession. Those downward revisions are a strong clue that things are not going that well.

But there is something else worth noting and that is the BLS breaks the payroll data down on a state-by-state basis as well. This is not something that gets a lot of press but is nonetheless important. While this data only goes back to 1976, that is still a fairly robust series. I highlight this because every time in the past, when all 50 states + Washington DC have seen a decline in the number of employed workers, we have been in a recession already. And shortly thereafter, the first negative NFP prints started showing up, usually withing 2-3 months. Well, guess what? Last month saw every state in the union report a decrease in the number of employed persons. This is quite a negative signal for the economy, and one that is not getting much press, certainly not from the soft-landing set.

I’m not saying that we are going to get a negative NFP print this morning, just that it seems one is coming to a screen near you soon. If history is any guide, then sometime in Q1 seems realistic. And ask yourself how Chairman Powell and his friends on the FOMC will respond to that type of data. They had better hope that the recent trend in inflation, which has clearly been on a downward trajectory, continues, because otherwise, the Chairman will have nowhere to hide. Cut rates to address economic weakness while stoking still firm inflation? Leave rates on hold to fight inflation and let growth crater further? Talk about a rock and a hard place.

It seems to me that the evidence continues to pile up on the side of a recession coming early next year. Absent another wave of MMT or helicopter money or some type of direct fiscal stimulus by the federal government, this business cycle seems destined to end soon. The bond market has been telling us that since the beginning of last month. The oil market has been telling us that since the beginning of last month too. The stock market has still not gotten the message. It will, trust me, and it won’t be pretty. However, I don’t think today is the day it will happen. Just be prepared.

So, how have markets performed leading up to the NFP data? Well, following yesterday’s rally in US stocks, Asia had a mixed picture. Japanese equities continue to be pressured by a combination of concern over tighter monetary policy and a strengthening yen. There was, however, a bump on the road to that tighter policy thesis as Q3 GDP was revised lower to -2.9% Y/Y, with the M/M falling -0.7%. Will they really tighten policy into a shrinking economy? Meanwhile, despite the word from the Chinese Politburo that they would be adding more fiscal stimulus in 2024, shares in Hong Kong and on the mainland barely eked out gains of 0.1%. The rest of APAC, though, had a decent performance, with gains ranging from 0.3%-0.9%.

European bourses are in good shape today, with green across the board, albeit some just barely (DAX +0.1%) and some more robustly (CAC +0.7%). Finally, US futures are edging lower, -0.2% or so, as I type (7:30am).

In the bond market, yields, which as we know have been trending sharply lower since early November, are rebounding slightly this morning with Treasuries up 3bps and European sovereigns all showing increases of between 5bps and 9bps. That seems a bit odd to me as there has been no data indicating inflation is rising or growth is impressive of late. In fact, the Eurozone inflation data continues to point to deflation as Germany’s final reading came in at -0.4% in November. In fact, as much as markets are expecting the Fed to cut rates soon, with a 60% probability now priced in for the March meeting, I suspect that the ECB is going to be cutting before the Fed as Eurozone growth and inflation are falling rapidly. As to JGB’s, yields there edged higher by 1bp overnight and currently sit at 0.75%, certainly not pressing on the 1.00% cap.

Turning to the commodity markets, oil (+2.2%) has finally found its footing with WTI back above $70/bbl. While there continue to be rumors that OPEC+ is going to cut production further, this feels much more like a trading bounce than a structural move. Interestingly, industrial metals are having a very good day with both copper and aluminum higher by 1% or more although gold is unchanged on the day. Ordinarily, I might attribute that to a weaker dollar except that the dollar’s not weaker this morning.

Speaking of the dollar, if you remove the yen from the equation, it has, in truth, been reasonably strong. Perhaps a better description is that other currencies have been weak as things like European economic doldrums weigh on those currencies while declining oil prices weigh on the petro-currencies. Now, for all the JPY bulls out there, be careful as the weakening GDP growth and the fact that the most recent CPI data, while still above target, started to decline means that there is less pressure on Ueda-san to change policy. Yes, they have started to discuss the idea of lifting rates out of negative territory, but they have also been quite clear that they need to see wage gains and the wage story really won’t be clear there until the March wage negotiations are completed. All I’m saying here is that we have come quite a long way in less than a month. Do not be surprised by a sharp rebound that wipes out a lot of profit and positions.

And that’s really it for the day. At 10:00 we also see the first cut of the Michigan Sentiment Index (exp 62.0) as well as the concurrent inflation expectations indices (1yr 4.5%, 5yr 3.3%). But by then, I expect that the excitement will have passed, and the market will be following whatever trend develops from the payrolls. If pressed, I expect a softer number, something like 100K and a tick higher to 4.0% on Unemployment. If that is correct, I expect that the market will continue with its ‘bad news is good’ concept and buy stocks in anticipation of Fed rate cuts. But remember, virtually every time the Fed is cutting rates aggressively because economic activity is declining, risk assets are being sold, not bought.

Good luck and good weekend

Adf

Buyers’ Chagrin

Posted on December 7, 2023 by fxpoet

Last month everything was just fine

As stocks traded up on cloud nine

But this week has been, 

To buyers’ chagrin,

Less fun, and perhaps e’en malign



While soft is the landing of choice

And one where the Fed would rejoice

As data keeps slipping

The narrative’s flipping

Said some, in a very low voice

Oops! ADP Employment fell further last month, down to 103K, well below forecast and moving into a more dangerous territory for the growth story. Last month’s outcome was revised lower as well and the 3-month moving average is now 99K. This is certainly not a level that inspires confidence in future economic activity. Now, we all know that ADP is not the really important number, that is Friday’s NFP, but of late, the story there has also not been that fantastic either. Last month printed just 150K, and revisions for virtually the entire year have been lower. All I’m saying is that I get a soft landing requires slowing growth which will impact the employment situation. But this is a $27 trillion economy, and not something that is steered so easily. Be prepared for the narrative to start to slip from soft-landing to recession and perhaps onto deep recession.

One number does not a trend make, but as I discussed yesterday, the weight of evidence is beginning to pile up on the slowing growth story. The market that really is buying the recession story is the oil market, where prices fell a further 4% yesterday with WTI settling below $70/bbl. That is not a market that is convinced demand is going to be robust!

I guess the question is, at what point does the data stop confirming the goldilocks wishes and point to a more significant economic decline? With respect to the employment situation, I suspect we will need to see a series of negative NFP prints as the Unemployment Rate rises. While the former has not yet been seen, the Unemployment Rate has risen by 0.5% over the past seven months. While tomorrow’s rate is forecast to be unchanged at 3.9%, there will be much angst in some circles if it goes higher. As far as other metrics, Retail Sales, which had a very strong run in Q3, slipped last month and is forecast to be -0.1% when released next week. Currently, the GDPNow forecast from the Atlanta Fed is calling for a 1.3% growth rate in Q4, much weaker than last quarter but not recessionary.

Combining these ideas, plus the other ancillary ones that come from the plethora of data released each month, it is easy to understand the belief in the soft landing. But remember this, monetary policy famously works with long and variable lags. That is just as true when the Fed is easing policy as when they are tightening policy. Currently, there is an ongoing debate over whether the Fed’s 525 basis points of tightening is fully embedded in the economy, or if there is still more pain to come. But if we are already seeing economic activity slow and the Fed continues to expound its higher for longer mantra, it is easy to make the case that the slowdown will be far deeper than a soft landing.

One other thing, all this is happening while measured inflation remains well above the Fed’s target which is likely to remain a constraining factor on their behavior going forward. If pressed, I would say the economy is heading toward a more significant recession, probably starting in Q1 or early Q2 of next year unless we see a remarkable turn of events in the US. Given the intransigence that the current House of Representatives is demonstrating with respect to funding Ukraine, it appears that fiscal help may be a quarter or two later than hoped. Be prepared.

Is the BOJ

Ready to change policy?

No breath-holding please!

One other thing of note was an article in Nikkei Japan that discussed recent comments from Governor Ueda as well as Deputy Governor Himino, where the implication seems to be that the committee there is contemplating the idea of raising their base rate to 0.0% or even 0.1% from its current -0.1% level. Certainly, the market is willing to believe this story as evidenced by the moves last night where 10-year JGB yields jumped 11bps while the Nikkei fell 1.75%. As to the yen, this morning it is the outlier in the FX market, with a 1.4% rally and is now trading back to its strongest level (weakest dollar) since August. While the most recent inflation data from Japan has continued to show consumer prices rising above the BOJ’s 2% target, 19 straight months now, wages remain more benign and that is a key metric there. While I’m sure that the BOJ will alter policy at some point, it still feels like it is a mid 2024 event.

And one other thing to note with respect to USDJPY, tomorrow the December futures options on the CME expire and there is some very substantial open interest at strike prices right here. Apparently, a single buyer purchased upwards of $2 billion notional of JPY calls with strike prices ranging from 145.50 down to 144.75 back in mid-November, which are now at- and in-the-money. The thing to look for here is a choppier market as dealers hedge their gamma risk. And don’t be surprised if we see another leg lower in USDJPY before they expire tomorrow.

Ok, let’s look at how all the other markets have behaved overnight as we await today’s Initial Claims data, but more importantly, tomorrow’s payroll report. After another soft showing in the US yesterday regarding equity markets, Asia, aside from Japan were broadly weaker, albeit not dramatically so. In Europe, the screens are all red too, but the losses are quite small, between -0.1% and -0.2%. Adding to the idea that there is very little ongoing, US futures, at this hour (7:30) are essentially unchanged.

Turning to the bond markets, Treasury yields, which had fallen below 4.10% briefly yesterday, have bounced on the day and are firmer by 5bps. But European sovereign bonds are little changed on the day with only UK Gilts (+5bps) an outlier here. Perhaps that move was on the back of the Halifax House Price Index, which rose slightly more than expected, but I suspect it has more to do with position adjustments ahead of tomorrow’s US payroll data. After all, remember, the US is still the straw that stirs the drink.

After a horrific day yesterday, oil (+0.6%) is trying to stabilize although WTI remains below $70/bbl. There is now talk in the market that OPEC+ is going to cut production further, although given they just held their monthly confab last week, this seems premature. Gold (+0.4%) is finding support again after its wild ride earlier in the week, and copper and aluminum are both showing green today.

Finally, the dollar, away from the yen, is mixed with modest weakness vs. most G10 currencies, and a completely uncertain picture in the EMG bloc. For instance, MXN (-0.5%) is under pressure this morning while ZAR (+0.9%) is putting in quite a performance. Looking at the entire space, it is hard to characterize a general theme here today. As such, it strikes me that choppiness ahead of tomorrow’s data is the most likely outcome in the session.

As mentioned before, Initial (exp 222K) and Continuing (1910K) Claims are the only data this morning although we do see Consumer Credit ($9.0B) this afternoon at 3:00pm. Right now, the dollar is trendless, except perhaps against the yen, although that means that hedging should be quite viable right now. As to the broader economic trend, tomorrow’s data will really set the tone for the FOMC meeting next week, and for Q1 next year.

Good luck

Adf

Hawk-Eyed

Posted on December 6, 2023 by fxpoet

A landing that’s soft will require

A joblessness growth multiplier

Demand needs to slide

Enough so hawk-eyed

Fed members, rate cuts can inspire



The thing is, when looking at data

The trend hasn’t been all that great-a

While prices are falling

Growth seems to be stalling

More quickly than Jay’d advocate-a

As we await the onslaught of data starting this morning with ADP Employment and culminating in Friday’s Payroll and Michigan Sentiment reports, I thought it would be worthwhile to try to take a more holistic look at the recent data releases to see if the goldilocks/soft landing narrative makes sense, or if there is a growing probability of a more imposing slowdown in growth, aka a recession.

The problem is, when looking at the past one month’s worth of data, the trend in either direction is not that clear. One of the things that has been true for a while is that there continues to be a dichotomy between the survey data and the hard figures. Survey data has tended toward weakness, with one outlier, the most recent Chicago PMI print at 55.8. But otherwise, ISM data has been quite soft for manufacturing and so-so for services. Looking at the regional Fed surveys, it has been generally much worse with more negative outcomes than positive ones.

At the same time, we all remember last week’s blowout GDP result for Q3 at 5.2% and we continue to see employment growth, albeit at a slowing pace to what was ongoing last year and earlier this year. Retail Sales finally fell slightly last month, but that is after a string of much stronger than expected prints, arguably why Q3 GDP was so strong. Perhaps the more worrying points are that the Continuing Claims data has started to grow more rapidly, meaning that people are remaining on unemployment insurance for longer and longer periods and yesterday’s JOLTS data was substantially lower than expectations and lower than the November reading. Finally, Durable Goods and Factory Orders have been quite weak.

If I try to add it up, it seems to point to a weaker outcome than a soft-landing with the proper question, will the recession be mild or sharp? Funnily enough I think the data highlights the Biden administration’s ‘messaging’ problem. Surveys are generally quite negative and now hard data seems to be rolling over. That is clearly not the story that a president running for re-election is seeking to tell.

All this begs the question, how will the Fed respond? And here’s the deal, at least in this poet’s view; the current market pricing of upwards of 125 basis points of rate cuts through 2024 is not the most likely outcome. Rather, I continue to strongly believe that we will see either very little movement, as higher for longer maintains, or we will see 300-350bps of cuts as a full-blown recession becomes evident.

To complete the exercise, let’s game out how markets may behave in those two situations. If the Fed holds to its guns and maintains the current policy stance with Fed funds at 5.50% and QT ongoing, risk assets seem likely to have problems going forward. It is quite easy to believe that the key driver to last month’s massive equity rally was the pricing of easier monetary policy to support the economy, and by extension profitability and the stock market. So, if the Fed does not accommodate this view, at some point investors and traders are going to need to reevaluate the pricing of their holdings and we could see a sharp decline in equities. As well, this would likely result in a further inversion in the yield curve as expectations for a future recession would grow. On the commodity front, this ought to weigh on both the energy and metals complexes even further than their current pricing. Recall, I have been highlighting that the commodities markets seem to be the only ones pricing in a recession. As to the dollar, in this scenario I expect to see it regain its strength as the rest of the world will be sliding into recession regardless of the US outcome, so rate cuts will be on the table for the ECB, BOE, BOC, and PBOC.

Alternatively, the economic situation in the US could well deteriorate far more rapidly than the current goldilocks set believes. In fact, I believe that is what it will take to get the much larger rate cuts that everybody seems to be pining for. But ask yourself, do you really want rate cuts because economic activity is collapsing? That seems a tough time to be snapping up risk assets. In fact, historically, equity market declines through recessions occur while the central bank is cutting rates. Be careful what you wish for here.

But, to finish the scenario analysis, much weaker economic data (think negative NFP as a first step along with Unemployment at 4.5%) will almost certainly result in cyclically declining inflation data and a dramatic fall in demand. So, equity markets would be under pressure everywhere. meanwhile, the normalization of the yield curve would finally occur with the front end falling far faster than the back. In the commodity markets, I think precious metals will outperform as real rates tumble and safety is sought. However, industrial metals would decline and likely so would energy prices, both driving inflation lower. As to the dollar, this is much trickier. At this point, I would argue the Eurozone is ahead of the US in the economic down wave and so will also be cutting rates. The dollar’s performance will be a product of the relative policy response and I suspect will result in a very choppy market. At least against G10 currencies. Versus its EMG counterparts, I suspect the dollar will significantly underperform absent a global recession.

But enough daydreaming, let’s take a look at the overnight session. From an equity perspective, yesterday’s late rally in the US, getting things back close to unchanged, was followed by strength in Asia, notably in Japan (Nikkei +2.0%) but also across the board with India’s Sensex making yet more new all-time highs, and modest strength in Europe despite some weak German Factory Orders data. Or perhaps because of that as traders grow their belief the ECB is going to start cutting rates soon. US futures are edging higher at this hour (7:00), but only by 0.2% or so.

In the bond market, after a day where yields fell sharply, this morning we are seeing a slight bounce with Treasury yields backing up by 3bps and European sovereign yields edging higher by between 1bp and 3bps. The European bond market is clearly of the opinion that the ECB is done hiking with that confirmation coming from the Schnabel comments yesterday morning. Now, the only question is when they start to cut. Something else to note is that JGB yields have fallen 3bps this morning and are essentially back at levels seen in early September before the BOJ’s latest comments about the 1% cap being a guideline, not a hard cap. Perhaps the argument that the BOJ was going to normalize its policy was a bit premature.

On the commodity front, oil prices continue to slide, down another 0.7% this morning and nearly 8% this week. While this is great for when we go to fill up the gas tank, it is a harbinger of a weaker economy going forward, which may not be so great overall. Gold prices have stabilized and are still above $2000/oz and we are also seeing stabilization in the base metals prices right now.

Finally, the dollar, which rallied nicely yesterday, and in fact has been climbing for the past week, is little changed this morning stabilizing with the euro below 1.08 and USDJPY above 147. There continues to be a narrative that is calling for the dollar’s demise, and in fact, I understand the idea based on the belief that the Fed is turning easy. But for right now, it is also becoming clear that the rest of the world’s central banks are rolling over on their policy tightening and given the lack of a strong interest rate incentive, plus the fact that a weaker global economy will send investors looking for safe havens, the dollar is likely to maintain its recent strength, if not strengthen further going forward. In order to see a substantial dollar decline, IMHO, we will need to see the US enter a sharp recession without the rest of the world following in our footsteps. As I see that to be an unlikely outcome, my guess is we have seen the bottom of the dollar for the foreseeable future.

On the data front, we start today with the ADP Employment (exp 130K) and also see the Trade Balance (-$64.2B), Nonfarm Productivity (4.9%) and Unit Labor Costs (-0.9%). From North of the Border, at 10:00 we see the Ivey PMI (their ISM data, expected at 54.2) and the BOC interest rate decision where there is no change expected and there is no press conference either.

I really wanted to get bearish on the dollar and felt that way when we heard Fed Governor Waller talk about rate cuts, but lately, the news from everywhere is negative and I just don’t see the dollar suffering in this situation. Stable, yes; falling no.

Good luck

Adf

Bad News is Good

Posted on November 6, 2023 by fxpoet

It seems that when bad news is good
Some things are not well understood
So, risk assets rally
And traders who dally
Miss out making gains that they could

But that was the story last week
And looking ahead we shall seek
The narrative changes
That altered the ranges
Of assets that used to look bleak

It has been a pretty quiet session overall and, in truth, the upcoming week does not look all that interesting from a market perspective. While we do get the RBA policy announcement tonight (exp 25bp hike to 4.35%), and a great deal of Fedspeak including Powell on both Wednesday and Thursday, from a data perspective, there is nothing of note on the horizon.

As such, I feel like it is a good time to review the recent data and policy decisions that have led to the market gyrations through which we have been living. If you recall, heading into last week, the narrative had been focused on the continued bear steepening of the yield curve as bond yields were rising on the anticipation of a significant increase in supply. This movement was weighing on equity markets, which had just finished an awful week. While risk was under pressure, we saw dollar strength although oil markets were in the midst of pricing out an expansion of the Israeli-Hamas conflict into a wider Middle East war impacting oil production or shipments. Generally, the mood was bearish and there were many questions as to the timing of the much-anticipated recession.

And then last week turned almost everything on its head. Starting with the BOJ, which adjusted its YCC policy again, although in a more flexible manner, removing the hard cap on yields at 1.00% and instead calling that a goal, rather than a cap. Not surprisingly, the first move was for JGB yields to rise sharply, although they have not yet touched 1.00%, and, also, not surprisingly, the BOJ was in the market with an unscheduled round of JGB purchases the next day. In the end, I think it is fair to say that while the BOJ is still running the easiest monetary policy in the world, it is somewhat tighter at the margin.

Meanwhile, the Fed’s reaction function seems to have been adjusted by the bond market’s bear steepening price action. Several weeks prior to the FOMC meeting last week, Dallas Fed President Lorrie Logan was the first to mention that higher long-dated yields were tightening financial conditions and doing some of the Fed’s work for them. Subsequently, we heard several other Fed speakers reiterate that idea, with some going as far as saying they thought it was worth between 50bps and 75bps of tightening. At the FOMC press conference last Wednesday, Chairman Powell jumped on that bandwagon, and though he attempted to sound somewhat hawkish, claiming that they remained data dependent and if inflation remained hot, they would hike again, nobody really believes him anymore. According to the Fed funds futures market, the current probability of a rate hike in December is down to 9.8%. That was nearly 30% just before the FOMC meeting and has been sliding ever since.

It seems fair to ask, what has changed all these attitudes? I would argue that the Treasury’s Quarterly Refunding Announcement (QRA) which is generally completely under the radar, was the big news that altered the narrative. Then, adding to the new momentum, we got clearly weaker than expected employment data, implying that the Fed’s data dependence was going to be heading toward rate cuts sooner rather than rate hikes at all.

Briefly, the QRA is, as its name suggests, the document the Treasury issues each quarter to inform the market of how much new Treasury debt will be issued for the next two quarters, as well as the anticipated mix of issuance between T-bills and longer dated coupons. In the most recent version, Secretary Yellen indicated that the Q4 issuance would be lower than had previously been expected, and she also indicated that a greater proportion would be in T-bills than expected. The combination of these two features cut the legs out from under the oversupply issue, at least temporarily (there is still an enormous amount of debt coming) and combined with what had clearly been developing short bond positions by the hedge fund and CTA communities, saw a major reversal in bond prices with yields declining > 40bps last week.

It should be no surprise that stock markets took that news and ran with it. Part of the previous narrative was the continuous rise in yields was devaluing future earnings in the equity market. As well, earnings season saw decent numbers, but lots of lower guidance by company management downgrading future assessments. While Q3 GDP was a hot, hot, hot 4.9%, the Atlanta Fed’s first look at Q4 GDP is for a much more sedate 1.2%. If that is what Q4 is going to look like, it is hard to get excited about earnings growth. So, prior to last week, equity markets had declined ~10% from their recent highs, a very normal correction, and the big question was, is this the beginning of the next leg lower in a longer-term bear market, or was this just a correction?

Taken together, and adding in a much weaker than forecast NFP report on Friday, where the headline number fell to 150K, and there were revisions lower for the previous two months by an additional 40K while the Unemployment Rate ticked up to 3.9%, its highest print since January 2022 and 0.5% higher than the cycle lows, the new market narrative seems to be as follows: the Fed is done hiking and the only question is when they will start to cut rates. The high in longer-term yields has been seen as well since the data is starting to roll over. This will lead to further downward pressure on inflation and the soft landing will be completed. The upshot of this narrative is, of course, BUY STONKS!!!

And that was the outcome from Wednesday on last week, a major reversal in equity market weakness, a huge rally in bond prices and decline in yields and a general warm and fuzzy feeling. And who knows, maybe they will be correct. But…

The combination of higher stocks and lower bond yields has eased financial conditions considerably in just the past week. This implies the Fed may be forced to act to continue their program lest inflation reasserts itself.
The idea that slowing growth is a positive for equity prices seems a bit skewed as slowing growth typically leads to weaker profits.
Inflation is not dead yet, and the most recent Core PCE reading did not indicate that it is slowing that rapidly. As can be seen from the chart below, 0.3% M/M PCE equates to 3.6% annual, well above the Fed’s target.

While I believe that the market is going to run with this narrative for a while, and we could easily see stocks continue to rebound and yields grind a touch lower, I fear that reality will set in soon enough and these moves will prove ephemeral.

Tying this up with a bow on the dollar leaves me with the following view; as long as this current narrative holds, the dollar will remain under pressure. I suspect this can last through the end of the year, although much beyond that I am far less certain. I would contend there are two ways things can evolve from here:

This relaxation in financial conditions forces the Fed to reassert themselves and they start hiking rates again. In this case, the dollar will once again rise as no other central banks will have the ability to keep up with a newly hawkish Fed, or
The much-anticipated recession finally shows up, perhaps in Q1 2024, and the Fed, after a little hesitation starts to ease policy. However, by that time, I suspect that the rest of the world will also be in recession and central banks elsewhere will be cutting rates even more quickly. While the dollar is likely to slide initially, I don’t think it will decline very far as in that situation, it seems likely that the US will remain the proverbial ‘cleanest shirt in the dirty laundry.’

As for today, it is hard to get excited about anything really, at least with respect to the FX market.

There will be no poetry tomorrow, but I will return on Wednesday.

Good luck

Adf

No Longer a Threat

Posted on November 3, 2023 by fxpoet

Opinions are already set
The Fed is no longer a threat
Today’s NFP
Will help all to see
That buying stocks is the best bet

At least that’s the narrative tale
The talking heads want to prevail
The question’s, will Jay
Have something to say
If finance conditions, up, scale

To conclude what has already been a tumultuous week, this morning brings the monthly payroll report, a key piece of evidence for the Fed to determine the health of the economy. Expectations for the readings are as follows:

Nonfarm Payrolls	180K
Private Payrolls	158K
Manufacturing Payrolls	-10K
Unemployment Rate	3.8%
Average Hourly Earnings	0.3% (4.0% Y/Y)
Average Weekly Hours	34.4
ISM Services	53.0

Source: tradingeconomics.com

Apparently, the whisper number is a bit above 200K, but we also must pay close attention to the revisions. Recall last month had a blowout 336K result, which was much larger than expected. If that number retains its strength, it would certainly be indicative of a still healthy labor market. This matters a great deal as after Powell’s press conference on Wednesday and the surprising QRA that shortened the duration of upcoming Treasury bond issuance, the market is all in on the goldilocks story, solid growth with low inflation. The corollary to this is that the market is looking for the Fed to back off the current rate policy and begin to reduce the Fed funds rate, thus helping all the DCF models pump up the value of equities.

But even though I have been highlighting the importance of the NFP number for the past two years as a key for the FOMC, it is not clear to me that today’s is so important. I only say this because the Fed just met two days ago, and we will see another NFP before they meet again. Arguably, this one will get lost in the fog of memory.

If that is the case, then it is probably a good time to recap what we have seen this week and how it has affected market sentiment. The bulls are on a roll right now as we have seen a significant pullback in Treasury yields with 10yr down to 4.66%, down 36bps from their peak back on October 23^rd. While that is certainly a large move in a short period of time, it is in line with the types of movement we have been seeing all year, so hardly unprecedented. But Powell’s comments, which have been read as dovish despite his best efforts to prevent that view, and the bond market movement have many market participants licking their chops for a massive equity rally going forward.

Interestingly, one of the things the talking heads have been using to pump their story has been the tightening in financial conditions that were a result of declining stock and bond prices. The whole issue of tighter financial conditions doing the Fed’s work for them has been a key story for the past several weeks since it was first mentioned by Dallas Fed President Lorrie Logan. However, the big rally in both stocks and bonds, as well as the decline in the dollar, are all critical features in the calculation of those financial conditions, and they are all pointing to easier conditions. The point is, if tighter conditions was a reason for the Fed to have stopped tightening further, the fact that they are now easing implies the Fed may feel the need to raise rates again in December, although that is clearly not the consensus view.

At any rate, right now, momentum is on the bulls’ side, and it is tough to overcome. Certainly, the economic data continues to point to a resilient economy which implies, to me at least, that the Fed will not feel any urgency to cut rates soon. There has also been a great deal of discussion regarding the fact that the average time the Fed has held rates at a peak before cutting is just 7 months. We are now three months into the most recent hold, and, by definition, since the next meeting is not until December, we will be at 5 months then. My observation about Chairman Powell, though, is at this point he is unconcerned with statistics of that nature and is far more focused on achieving their objective of 2% inflation.

One last thing about inflation before we touch on markets. There has been a growing chorus that deflation is on its way because M2 money supply growth is currently declining. However, for the economics majors out there, recall that the key monetary equation is M*V = P*Q. P = prices, and Q = quantity of goods, or, combined economic output. M = Money supply and V = Velocity of money. It is the last piece that is often ignored but remains quite important. My good friend @inflation_guy, has just published a piece which is well worth reading. The essence is that while M2 may be declining, V is rising rapidly, offsetting that impact and creating conditions for much stickier inflation than many believe. I have a feeling the Fed is going to stay on hold, if not tighten further, for a much longer time than currently anticipated. While this week’s news has clearly been seen as bullish, the long-term trends have not yet changed in my view.

Ok, so a quick look at markets shows that after another gangbusters day in the US, where all three major indices were higher by 1.7% or more, Asian markets followed suit, with virtually every index there higher by at least 1.0%. Europe, however, has been more circumspect with markets essentially unchanged this morning, just +/- 0.1% on the day. US futures are ever so slightly softer at this hour (7:30) down about -0.15% on average, as investors and traders await this morning’s data.

At this point, bonds seem to be taking a rest after a huge price rally / yield decline over the past several sessions and we are seeing very little movement on the day with Treasuries and European sovereigns all within 1 basis point of yesterday’s closing. Even JGB yields slid a bit yesterday but remain above 0.90% as of now. As to the shape of the yield curve, that inversion is starting to show its head again, with the current 2yr-10yr spread back to -32bps. Remember, two days ago that was at -18bps. Broadly speaking, yield curve inversions are not signs of economic strength.

In the commodity space, oil is creeping back higher, up 0.4% this morning although still lower on the week. Gold is basically unchanged this morning, continuing to hang out just below $2000/oz, which continues to surprise me given the sharp decline in yields, at least nominal yields. As to the rest of the space, base metals are mixed amid small changes this morning and foodstuffs, something I have not mentioned in a while, have actually been declining with the FAO’s world food price index falling to its lowest level in more than 2 years last month. It may not seem that way in the grocery store, but perhaps future price rises will be more muted.

Finally, the dollar is generally biding its time ahead of the data, although leaning lower overall. In the G10, the average gain of a currency is about 0.2% while in the EMG bloc we have seen a few outliers, notably KRW (+1.2%) but a more general rise of 0.4% or so. You already know that my view has changed given the seeming change in the underlying drivers. For now, and likely through the end of the year at least, I think the dollar will be under pressure.

Aside from the data this morning, we get our first Fed speaker, Supervision Vice-Chair Michael Barr, this afternoon, but the topic is the Community Reinvestment Act, which makes it unlikely he will swerve into monetary policy. So, as is often the case, the data will see a flurry of activity at 8:30 and then I suspect the recent trends will reassert themselves in a slower session overall. We will need to see an extraordinarily strong NFP print to help reverse the dollar’s current malaise.

Good luck and good weekend

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A Havoc Nightmare

Posted on October 30, 2023 by fxpoet

While real wages fall
Kishida’s polls fall faster
Will Ueda act?

The first big thing this week is tonight’s BOJ meeting where many in the market are anticipating another tweak to the current YCC framework. I have seen several analysts calling for a widening of the band to +/- 1.25% from the current +/- 1.00%. While current yields have yet to reach the cap, they continue to grind higher and are currently at 0.88%, new highs for the move. Ironically, it is likely the BOJ will need to buy even more JGB’s if they make an adjustment as the wider band would give the green light for speculators to short bonds even more aggressively. Recall, since they widened from 0.50% to 1.00%, there have been at least five unscheduled bond buying episodes by the BOJ, with the last one, just a week ago, being the largest to date.

One thing to remember about the BOJ is that the concept of central bank independence is not as strong in Japan as it is, perhaps, elsewhere in the Western world. (Of course, it is not that strong elsewhere either, but Japan is closer to China on this front than the US). At any rate, the most recent polls in Japan show that PM Kishida’s approval ratings have fallen to new lows for his tenure, with an approval of just 33% according to the most recent Nikkei poll. And this was after the announcement that he was cutting taxes to help people deal with the consistently rising inflation in Japan. While it has not grown to levels seen in the US or Europe, it is clearly far higher than they have seen there in more than a generation.

But it doesn’t seem to be enough. Now, there is no requirement for an election until sometime in 2025, but that doesn’t mean Kishida-san won’t feel the pressure to do more. And arguably, one of the things they can do to fight inflation is raise rates and see if the yen can recapture some of the 35%+ that it has declined over the past two years.

So, will they act? My one observation on this is that unlike the Fed, which never likes to surprise the market, the BOJ has figured out that they only way they can have an impact is if they do surprise the market. Given that an increasing number of people are starting to look for this outcome, I think the probability of a BOJ policy change tonight is quite low. I would not be surprised, if I am correct, to see USDJPY head back through 150 and start to grind to new highs above the 152+ peak seen just before the intervention last year.

Meanwhile, for the rest of the week
Both meetings and data might wreak
A havoc nightmare
So, traders, beware
Of comments or data that’s bleak

Beyond tonight’s BOJ meeting, the week is jam-packed with other potential market moving catalysts between central bank meetings (FOMC on Wednesday, BOE on Thursday) and important data including ISM (Wednesday) and NFP on Friday. However, there is one other thing set to be released Wednesday morning, well before the FOMC announcement and that is the Quarterly Refunding Announcement (QRA). While, as its name suggests, this is released every quarter, it has generally been relegated to the agate type of market information as a technical feature for bond traders. But this time, it has gained far more interest given the combination of the bond market’s performance since the last QRA (yields are higher by 80ish basis points) and the fact that the government budget deficit is continuing to grow with many new forecasts for a $2 trillion deficit this year thus a need for even more borrowing.

Back in August at the last QRA, the Treasury increased issuance more than anticipated which has been seen as one of the drivers of the recent bond market decline. If they were to increase it significantly again, there is certainly concern that bond yields can move much higher still. Now, the Treasury could issue more short-term T-bills to take pressure off the bond market but bills already represent about 22% of the total debt outstanding. That is a couple of points higher than the top of the historic range of 15%-20% and may be seen as a point of contention. The positive is that given T-bill yields are all above 5.3%, there will be plenty of demand for their issuance. However, on the flip side, that means that refinancing will need to occur far more frequently and that makes it subject to market dislocations and disruptions.

Another key part of the discussion will be just how large Secretary Yellen wants to keep the Treasury General Account (TGA), which is the government’s ‘checking’ account at the Fed. As of Thursday, it held $835 billion and there has been talk she wants to increase it to $1 trillion to make sure the government has ample liquidity going forward, especially if there is another issue regarding government financing in Congress. Historically, the Treasury has issued bills when they are seeking to build up balances in the TGA, which would tend toward seeing even more bills issued rather than substantial growth in the longer-dated maturities. All in all, it is possible the QRA is going to have the largest potential impact on markets this week so beware.

In truth, the overnight session has been somewhat dull. While the Israeli-Palestinian situation has seemed to enter a new phase regarding Israel’s incursion into Gaza, markets are non-plussed over the matter with bond yields little changed across the board, the dollar little changed across the board and oil prices sliding (-1.5%) this morning. Even gold (-0.6%), which has been the best performer in the wake of the middle east crisis, has slipped back below the $2000/oz level, although remains higher by almost 10% in the past month.

In fact, the one area where things are moving is in equity space where we are seeing gains across the board in Europe, somewhere between 0.5% and 1.1%, in the major bourses as inflation data there showed that price rises have begun to slow down and Germany’s economy “only” shrunk by -0.1% in Q3, a much better than expected outcome! US futures are also higher at this hour (7:15), up by 0.5% or so after a pretty awful week last week. In fact, the only real outlier was Japan where the Nikkei slid -0.5% as Chinese shares were stronger along with most of the APAC markets.

As mentioned earlier, though, we do have a lot of news coming out this week so let’s go through it here:

Tuesday	BOJ Rate Decision	-0.1% (unchanged)
	BOJ YCC	+ / – 1.00% (unchanged)
	Case Shiller Home Prices	1.6%
	Chicago PMI	45
	Consumer Confidence	100
Wednesday	ADP Employment	150K
	QRA	$114 billion (+$11 billion)
	ISM Manufacturing	49.0
	JOLTS Job Openings	9.2M
	Construction Spending	0.4%
	FOMC Decision	5.5% (unchanged)
Thursday	BOE Decision	5.25% (unchanged)
	Initial Claims	210K
	Continuing Claims	1795K
	Nonfarm Productivity	4.0%
	Unit Labor Costs	0.8%
	Factory Orders	1.9%
Friday	Nonfarm Payrolls	188K
	Private Payrolls	145K
	Manufacturing Payrolls	0K
	Unemployment Rate	3.8%
	Average Hourly Earnings	0.3% (4.0% Y/Y)
	Average Weekly Hours	34.4
	ISM Services	53.0

Source: tradingeconomics.com

So, as you can see, there is a lot of stuff coming our way starting tonight in Tokyo. What that tells me is that we are not likely to see very much movement today as traders and investors await the plethora of new information that is due. However, by the end of the week, we could have a very different narrative.

Good luck

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fxpoetry

Explaining the rhyme and rhythm of the FX markets each day

Tag Archives: #NFP

Ending QT

Quite Frail

Dragged Through the Mud

The New Allegory

Jay Powell’s Dream

Buyers’ Chagrin

Hawk-Eyed

Bad News is Good

No Longer a Threat

A Havoc Nightmare