Tag Archives: #PCE

Crying Again

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The boy who cried wolf
Better known as, Mr Yen
Is crying again

 

Masato Kanda, the vice finance minister for international affairs, also known as ‘Mr Yen’ was interviewed last night regarding the recent yen’s recent weakness.  “I strongly feel the recent sharp depreciation of the yen is unusual, given fundamentals such as the inflation trend and outlook, as well as the direction of monetary policy and yields in Japan and the US.  Many people think the yen is now moving in the opposite direction of where it should be going.  We are currently monitoring developments in the foreign exchange market with a high sense of urgency. We will take appropriate measures against excessive foreign exchange moves without ruling out any options.”

His comments [emphasis added] are consistent with what we have heard from FinMin Suzuki, PM Kishida and from him previously.  What makes this so interesting is that USDJPY is essentially unchanged from its level 10 days ago, immediately in the wake of the BOJ meeting.  While we did touch a new yen low (dollar high) earlier this week, that level was just a single pip weaker than the level seen back in 2022 (grey line) that seemed to be the intervention trigger at the time.  And consider, much has passed between then and now, with inflation in Japan (blue shaded area) having fallen back to levels last seen at that time, but now trending in the opposite direction.  

Source: tradingeconomics.com

It is abundantly clear that the MOF is concerned over a sharp decline in the yen.  It is also clear that the monetary policy differences between the US and Japan are such that there is very little reason for the yen to appreciate at the current time.  This is especially true since the US commentary we have heard lately, with Waller’s comments on Wednesday the most recent, indicate that the long-awaited Fed pivot continues to be a distant prospect, while Ueda-san made it clear that the BOJ was going to maintain easy money conditions despite having exited NIRP. 

FWIW, absent a sudden sharp move above 153, my take is the MOF/BOJ simply continue to jawbone the market.  However, if something changes and we rip higher in USDJPY, that would change my views.  

Though holiday markets abound
The info today could astound
At first, PCE
With fears it’s o’er three
Then Powell with words quite profound

And what, you might ask, could cause such a move in the FX markets?  Well, despite the fact that all of Europe and Canada are closed as well as both equity and futures exchanges in the US in observance of the Good Friday holiday, this morning we have critical US economic data being released at 8:30 as well as a speech by Chairman Powell at 11:30.  Liquidity is abysmal, which means that if the data is a surprise in either direction, we could see an outsized move in the dollar.  And then, Powell’s timing is such that even the skeleton staffs at European banks are likely to have gone home by the time he speaks. 

Given the recent commentary we have heard from other FOMC members, it is almost a certainty that there will be some movement.  Consider, if Powell pushes back and sounds dovish, that will change attitudes that have been adjusting to a more hawkish view.  At the same time, if he comes across as hawkish, that will be seen as confirmation that the Fed is on hold for much longer, and markets will continue to price out rate cuts.  Do not be surprised to see different prices on your screen when you come in on Monday.  Recognize, too, that Easter Monday is a holiday in many Eurozone countries as well, so liquidity will still not be back to normal.  It is for these situations that a consistent hedging program is needed.

Ok, that pretty much sums up the overnight session as well as a peek at what’s in store.  Asian equity markets were firmer overnight as the weak yen continues to support the Nikkei, while Chinese shares have benefitted from a story making the rounds that Xi Jinpeng, in an unpublished speech from last October, explained he thought the PBOC needed to consider QE, at least that’s the context.  He didn’t actually use the term QE.  But if that is the case, that is a huge consideration for Chinese asset prices.  We shall see.  Meanwhile, European bourses are all closed as are US futures markets.

Not surprisingly, bond markets have also been closed in Europe but it is noteworthy that Chinese 10-year yields fell to 2.20%, a new all-time low, on the back of the QE story.

Commodity markets are also shut, but I must explain that yesterday, gold rose 1.75% to yet another new high price at $2232/oz.  I believe its performance is quite a condemnation of the current monetary and fiscal policy stances around the world as investors, both public and private, are growing increasingly concerned that there is going to be a comeuppance in the future.

Finally, the FX markets are really the only ones that are open, and the dollar has continued to edge higher overall.  The euro is below 1.08, its lowest level in a month while USDJPY hovers just below its recent highs and USDCNY similarly hovers below its recent highs with both longer term trends clearly higher.  I repeat, this is all policy driven and until policies change, neither will these trends.

Let’s look at what the consensus views are for this morning’s data.  

Personal Income0.4%
Personal Spending0.5%
PCE0.4% (2.5% Y/Y)
Core PCE0.3% (2.8% Y/Y)
Source: tradingeconomics.com

While those Y/Y numbers are not terribly high, the problem is they have stopped trending lower.  Based on the CPI data from earlier in the month, another 0.4% print in the headline will more convincingly turn that trend back higher and that is exactly what frightens the Fed.  And if it’s a tick higher, heads will explode as their confidence in achieving their mooted goal of 2% will take a major hit.  I think the response here will be completely as one would expect; hot print means stronger dollar; cool print means weaker dollar, in-line print means no movement ahead of Powell’s speech.  Let’s see what happens!

Good luck and good weekend

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Not In a Rush

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Said Waller, I’m not in a rush
To cut, though some hopes that may crush
Inflation’s still sticky
And so, it’s quite tricky
For us to cut with prices flush
 
He also said that PCE
Tomorrow, may help him to see
If trends from Q4
Still hold anymore
Or whether its new home is three

 

Investors and traders have a problem, or perhaps several of them.  The timing of key data and events coincides with the Easter holiday weekend as well as month- and quarter-ends (and for Japan, fiscal year end).  Their problem is to discern how much movement is based on new information and the anticipation of tomorrow’s releases versus how much movement is a result of declining liquidity as trading desks throughout Europe see staff exit early for the holiday weekend.  If movement is due to new information, perhaps a response is required.  However, if it is due to illiquidity, sitting tight may well be the right thing to do.

The biggest news yesterday came from a speech by Fed Governor Chris Waller.  He certainly didn’t bury the lead as this was his opening paragraph:

“We made a lot of headway toward our inflation goal in 2023, and the labor market moved substantially into better balance, all while holding the unemployment rate below 4 percent for nearly two years. But the data we have received so far this year has made me uncertain about the speed of continued progress. Back in February, I noted that data on fourth quarter gross domestic product (GDP) as well as January data on job growth and inflation came in hotter than expected. I concluded then that we needed time to verify that the progress on inflation we saw in the second half of 2023 would continue, which meant there was no rush to begin cutting interest rates to normalize the stance of monetary policy.”

He spent the rest of the speech going through particular details about the labor market and the broad economic measures and data we have seen with the conclusion being, higher for longer (H4L) is still the correct policy.  While he did not explicitly say he moved his ‘dot’ to less than three cuts, I believe we can infer that he is now in the 2-cut camp based on the entirety of the speech.

Given the absence of other data released yesterday, as well as the dearth of other commentary, he was the main event.  Interestingly, despite what appears to have been a more hawkish tone to his comments, equity markets were sanguine about the news and rallied anyway.  To me, that indicates equity investors have made their peace with the current interest rate structure.  

What does this mean for markets going forward?  First, let’s assume that there are three potential ways the Fed funds discussion can evolve going forward; 1) raising rates from here, 2) status quo (H4L) and 3) starting to reduce rates.  Based on recent market price action in both equities and bonds, there is very little fear attached to number 2.  Investors have absorbed this information, are pricing a 61% probability of a June rate cut but are now pricing slightly less than 3 cuts in for the rest of the year.  In other words, H4L is no longer frightening.  The key near-term risk to markets is number 1; if the inflation data not merely drags on at current levels but starts to accelerate again.  I believe that is what would be necessary for the FOMC to consider tightening policy further and my take is that risk assets will not respond well to that situation.  Stocks would suffer on a valuation basis while bonds would likely sell off on the basis of still untamed inflation.

It is the third choice though, cutting rates, that is likely to generate the most fireworks.  Certainly, the initial movement will be a risk asset rally as investors will make the case that a lower discount rate means higher current values as well as invoke the idea that money currently invested in money-market funds will quickly move to stocks as interest rates decline.  At the same time, the front end of the yield curve will see yields decline amid what is likely to be a bull steepening of the curve.  And that’s the problem.  History has shown that when the curve re-steepens after a period of inversion, that is when trouble comes for markets.  As can be seen in the chart below from the St Louis Fed’s FRED database, the correlation between a declining Fed funds rate and a recession is very high (grey shaded areas represent recessions).  

This makes perfect sense as when the economy is heading into, or more likely already in, a recession, the Fed cuts rates to address the issue.  As such, the fervent desire to see rate cuts seems misplaced.  Strong economic activity comes alongside higher interest rates, not rate cuts.  If the Fed is cutting, that means there are problems as remember, whatever they say, they are always reactive, not proactive.  So, while the initial risk asset move may be positive, history has shown that during recessions, the average decline in the equity markets is on the order of 30%. Keep that in mind if you are hoping for the Fed to cut rates.

Ok, let’s tour the markets from overnight to see how things stand ahead of a bunch of data this morning. Japanese stocks suffered overnight, falling -1.5%, as the threat of intervention did little to strengthen the yen but certainly got some investors nervous.  As well, it is Fiscal year end there tonight, so I imagine we are seeing some profit taking given the remarkable run Japanese stocks have had in the past twelve months, rising 44% in yen terms.  The rest of Asia saw more gainers than losers with China, India and Australia all following the US markets higher although South Korea and Taiwan did lag.  In Europe, most bourses are higher this morning, but the gains have been more modest, on the order of 0.3% or so.  And as I write (7:30), US futures are unchanged on the day after yesterday’s gains.

In the bond market, yields are broadly higher with Treasuries (+3bps) reversing yesterday’s decline and similar price action in Europe with all sovereign yields higher by between 3bps and 5bps although Italy (+8bps) is an outlier as their finances are starting to look a bit dicier.  I would be remiss if I didn’t mention that JGB yields have edged down another basis point and are now at 0.70%.  There is no sign that yields are running away here.

Oil prices (+1.6%) continue to climb on the same story of reduced supply and ongoing demand.  Yesterday’s EIA data showed a smaller inventory build than forecast and there is no indication that OPEC+ is going to open the taps anytime soon.  Gold (+0.8%) is continuing its recent rally, following on yesterday’s move, as investors throughout Asia continue to hoard the barbarous relic.  As to the base metals, they are essentially unchanged over the past several sessions, seemingly waiting for the next economic data.

Finally, the dollar is feeling its oats this morning, rallying against every one of its G10 counterparts with this group (AUD -0.6%, NZD -0.6%, SEK -0.6%, NOK -0.6%) leading the way lower.  As well, the EMG bloc is also under pressure led by ZAR (-0.7%) and HUF (-0.6%) although the entire bloc is under pressure.  Of note is CNY (-0.15%) which the PBOC continues to struggle with as they cannot seem to decide if matching yen weakness is more important that maintaining stability.  It seems to me they are really hoping for BOJ intervention to reduce pressure on the renminbi.

On the data front, there is a bunch today starting with Initial (exp 215K) and Continuing (1808K) Claims, as well as the final look at Q4 GDP (3.2%).  As well we get Chicago PMI (46.0) and Michigan Sentiment (76.5) to finish out the morning.  There are no scheduled Fed speakers, but then, all eyes will be on Powell tomorrow.

It seems to me that Governor Waller made it clear that the tone in the Eccles Building is for more patience until they see inflation decline, or perhaps see the employment situation worse substantially.  With that as the backdrop, it is hard to see a good reason to sell dollars.  Keep that in mind for your hedging activities.

Good luck

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Who Do You Trust?

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At this point, it’s who do you trust?
‘Bout ‘flation, ‘cause as I’ve discussed
To some it seems hot
For others, it’s not
And so far, no one’s got it sussed

The thing is this PCE story
Is more than just mere allegory
Chair Jay and his team
Still harp on the theme
That higher for longer brings glory

I read far too much economic analysis each day as I try to glean interesting ideas from very smart people who are happy to offer them up.  Hopefully, my doing this allows you to spend your time doing more important things while still keeping abreast of the macroeconomic situation.  But, boy, I cannot remember a time when there was such vehement disagreement on a single statistic.  There have been many times where economic bulls look at all the data and see great things while the bears see death warmed over.  But that is generally based on a collection of items.  However, right now, literally every other piece that I read, all published by very reputable analysts and economists tells the opposite story.  One piece will explain that yesterday’s 0.4% rise in core PCE was just an aberration and that it is destined to reverse lower going forward largely because housing inflation is going to decline.  The next piece will point to yesterday’s release and explain that the recent three-month or six-month trend has turned higher in the critical core services component, and that there is no sign it is going to reverse.

The greatest (or worst) thing about economics is since it is not a hard science, everybody can have a view, typically back it up with some piece of data or another and make their case.  While ultimately, the proof is in the pudding, when economists are wrong, they will typically fall back on they missed the timing, not the actual direction of travel.

By this time, if you have been following my writings, you are aware I am in the ‘inflation is sticky’ camp, and I have not been surprised by the fact that it has stopped declining.  For 2 years we have been hearing that housing inflation is due to fall because of a massive supply of new apartments coming on the market soon, and yet I believe it is now 28 consecutive months where the housing component of CPI has risen at least 0.4% on the month.  I think one of the problems with the oversupply analysis is that it doesn’t account for the fact that a large proportion of those apartments are luxury apartments with very pricey rents.  As such, it is difficult for average or median rental prices to decline.  At the same time, the Case-Shiller Home price index rose 6.1% last month, which is not indicating any decline in single family home prices.  Given the proportion of housing in the inflation indices, whether CPI or PCE, if shelter costs are rising, you can bet that inflation will be rising.  And that’s where we stand.

The next question is, what does this mean for the Fed and their reaction function and then, how will it impact financial markets?  Well, we heard from four more Fed speakers yesterday and they remained consistent with their recent comments, i.e., there’s no need to rush as the economy remains strong and inflation isn’t declining as quickly as we hoped, but we remain confident that the time for rate cuts will come as the year progresses.  As of this morning, the market is pricing about an 80% chance of a June rate cut and is still pricing 3 ½ cuts for the year.  Meanwhile, Treasury yields have edged lower by 2bps, but remain well above the levels seen just one month ago, more than 40bps higher.  And lastly on this subject, equity markets are basically ignoring the data completely and focusing on internal factors like flows.  As such, my thought yesterday that they might stumble a bit, even with a lower PCE print, turned out to be completely wrong.  The party is still raging there.

As we look ahead, I would contend that the big picture remains exactly the same.  On the price front, yesterday’s data did nothing to dissuade me from my sticky inflation thesis.  At the same time, yesterday’s other data showed that manufacturing remains in a recession (Chicago PMI fell to 44.0), but the labor market is holding up (Initial Claims edged higher to 215K, although Continuing Claims were substantially higher at 1905K).  For much of last year I was far more focused on the NFP number as being the most important based on the idea that the Fed could not withstand a significant uptick in Unemployment for political reasons.  I have a sense that dynamic is going to reassert itself going forward.  If last month’s number was the aberration that many claim, and we see weakness next Friday, I believe that will really impact the narrative and we will see May come back on the table for the first rate cut.  But if it remains strong, the bar for cutting rates will remain quite high.

With that in mind, let’s look at the overnight session.  Asia was on fire with the Nikkei (+1.9%) leading the way after Ueda-san pushed back on the message from Takata we discussed yesterday.  He cautioned patience was necessary and until they saw and digested the wage outcomes later this month, there was no reason to do anything, especially given the recent weakness in GDP growth.  That caused the yen to give back yesterday’s gains and a weaker yen tends to help Japanese stocks.  But there was strength in China, albeit not as much, with the indices there and in Hong Kong rising by 0.5% or so.  We did see Chinese PMI data which printed as expected (Manufacturing 49.1, Non-Manufacturing 51.4, Caixin 50.9), which implies nothing has changed on the mainland regarding the economy.  Next week’s plenary sessions are still the China bulls’ hope for more stimulus.

European shares are generally firmer, with only the CAC (0.0%) the laggard as the rest are higher by 0.5% or more.  PMI data here was also largely in line with the Flash data last week and is being spun as the beginning of a turn higher.  However, ECB speakers continue to push back on the need for rate cuts soon which is not supporting equities on the continent.  As to the US futures market, after another rally to all-time highs yesterday, this morning sees very little movement ahead of the ISM data.

While Treasury yields have edged lower, all of Europe have seen their sovereign yields rise by between 3bps and 6bps, arguably on the idea that the worst of the economic story has passed.  I’m not sure I agree with that, but that is all I can get from the data.  Overnight, JGB yields edged 1bp higher, but are still sitting right at 0.70%, the level at which they have been trading for the past 5 weeks give or take a nickel.

Oil prices (+1.2%) are continuing their recent rise with WTI pushing back toward $80/bbl, as traders continue to expect OPEC+ to maintain their production cuts.  As well, from a market internal perspective, the backwardation in the curve is steepening.  Briefly, this means that front month prices are higher than prices further out the curve, which in the futures market is a signal that there is excess demand for physical.  That demand is the bullish signal.  As to the metals markets, gold (+0.5%) is breaking above its recent range high at $2050/oz, as the dollar, after a strong day yesterday, is ceding some of those gains.  However, base metals can’t get going with both copper and aluminum sliding by about -0.25% this morning.

Finally, as mentioned, the dollar is sagging a little with only the yen performing worse.  But its losses are generally quite modest, on the order of 0.1% or 0.2% for both G10 and EMG currencies.  And while it is under pressure today, the trend so far in 2024 is still very clearly for dollar strength.  Given the continued hawkish tone from the Fed, I see no reason for that to change anytime soon.

On the data front, both ISM Manufacturing (exp 49.5) and Michigan Sentiment (79.6) are due at 10:00 this morning and then we hear from five different Fed speakers as the day progresses, including Governor Waller, maybe the second most influential voice on the FOMC.  It is hard for me to believe that they are going to change their tune, especially given that yesterday’s PCE data gave no hint that their 2.0% target was right around the corner.

Summing up, consider the fact that the US continues to benefit from a massive fiscal impulse, relatively cheap and abundant energy prices and the tightest monetary policy in the G10.  With that in mind, we continue to see international capital flow into the country (look at the stock market!) and I suspect those things need to change for the dollar’s trend to change.  That is not going to happen today.

Good luck and good weekend
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Thought-Provoking

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My sight is clearing
I now see the price target
Closer than you think

“With monetary easing continuing, I believe we have reached a point where attainment of the 2% price stability target is finally in sight, despite uncertainty over the Japanese economy.  It is necessary to consider shifting gears from extremely powerful monetary easing … and how we should respond nimbly and flexibly toward an exit.”  So said BOJ member Hajime Takata last night at a meeting with business leaders in western Japan.  These are the strongest words we have heard, I would argue, and the market did respond with the yen strengthening (+0.5%) and now right on the 150.00 level, while 2yr JGB yields rose another basis point, up to 0.18%, and its highest level since 2011.  I always find the BOJ wording to be odd as they try to be nimble and flexible in something that doesn’t appear to offer opportunities to behave in that manner.

Regardless, this has encouraged a more hawkish take on Japan with the probability of their first rate hike occurring in March rising to 26% from a previous level in single digits.  But despite these comments, we must remember this is from a single BOJ speaker.  Unless and until we hear this tone from multiple BOJ board members, I maintain that while an April move to 0.00% is possible, movement much beyond that seems very premature.  After all, last night saw IP in Japan fall -7.5% in January which takes the Y/Y number to -1.5%.  Recall, too, that Japan is in the midst of a technical recession.  It just doesn’t seem like tightening monetary policy is the prescription for what ails that nation.

However, the Japanese story is for the future as we have already seen the initial knee-jerk reaction.  And that means that all eyes are going to be on the US data at 8:30.

So, what if Core PCE’s smoking?
It seems that might be thought-provoking
If that is the case
We’d all best embrace
The idea the bulls will start choking

The flipside’s a cool PCE
Which winds up at zero point three
If that’s the result
The stock-buying cult
Will take every offer they see

As the market awaits this morning’s PCE data, a quick recap of yesterday seems in order.  I think you can argue that the data indicated economic activity remains at quite a high pace.  While the second look at Q4 GDP was revised down a tick, it is still at 3.2%.  The sub-indices showed that prices rose a bit more than expected and that Real Consumer spending rose a better than expected 3.0%.  The other data point was the Goods Trade Balance which showed a larger than expected deficit, a sign that imports are growing faster than exports.  This is typically a growth scenario, not a recessionary one, so nothing about the data hinted at a slowdown in things.

As well, we heard from three different Fed speakers and to a (wo)man they all explained that they remain data dependent and that the total economic situation was what they were following, not simply the inflation rate.  My point is that there is no indication that they are anywhere near ready to cut rates.

Turning to this morning’s release, expectations are as follows: Headline (0.3%, 2.4% Y/Y) and Core (0.4%, 2.8% Y/Y).  As well, we do see some other important data with Personal Income (exp 0.4%), Personal Spending (0.2%), Initial Claims (210K), Continuing Claims (1874K) and Chicago PMI (48.0).  But really, it is all about PCE.

My take is things are quite binary for a miss from expectations.  A hot print, 0.5% or more, will result in a sharp risk-off session as market participants will reduce the probability of future rate cuts.  This should see both stocks and bonds sell off, while the dollar rallies.  In contrast, a 0.3% or lower print for Core PCE will see the opposite outcome with a massive equity rally along with a huge bond rally, especially the front of the curve, and I suspect that futures markets will juice the odds of a May cut again (March is off the table no matter what.)

Of course, the last choice is a release right at the consensus view.  In that case, both sides of this argument will continue to argue their points, but my take is, based on yesterday’s price action, that equities may have a bit further to correct on the downside absent some other news that encourages the idea of stronger real growth, or an increased probability of a Fed cut.  One other thing to remember is we get four more Fed speeches today and this evening, so regardless of the outcome, there will be a lot of opportunity to reinforce their views.

Heading into the data release, a quick look at the overnight session shows us that the Asian market was quite mixed with Japan very little changed, a small decline in Hong Kong, but mainland Chinese shares rose sharply (CS! 300 +1.9%) as traders are looking for the government to announce a new fiscal stimulus package after they meet next week and roll out their growth targets for the coming year.  it strikes me there is ample opportunity for disappointment here given how unwilling Xi has been to do just that.  The European picture is equally mixed with some gainers (UK and Germany) and some laggards (France and Spain) although not a huge amount of movement in either direction.  There was a lot of Eurozone data released this morning with weak German Retail Sales, slowing growth in Scandinavia, and inflation throughout the continent coming in just a touch hotter than forecasts, although still trending lower.  And, after a lackluster day yesterday, US futures are softer by -0.2% at this hour (7:00).

In the bond market, yields are rising this morning with Treasuries (+4bps) back above 4.30% and all European sovereigns rising by at least that much.  In fact, UK Gilts (+7bps) are leading the way after some slightly better than expected housing data.  10-year JGB yields also edged up by 1bp after the Takata comments, but remain far below the 1.00% level that is still seen as a YCC cap.

Oil prices are a touch softer this morning, -0.4%, after a modest gain yesterday.  The big story remains the rumors of OPEC+ continuing to restrict their production.  In the metals markets, precious metals are under modest pressure this morning, but base metals are holding their own, with aluminum leading the way higher by 0.6%.

Finally, the dollar, away from the yen, has really done very little overall.  Looking at my screen, the only currency that has moved more than 0.2% in either direction is NZD (-0.25%) which seems to be continuing yesterday’s price action after the less hawkish RBNZ meeting outcome.  Otherwise, nada.

As we await the PCE data, and the Fedspeak later in the day, the one thing to remember is that if we see a soft number and the equity market cannot hold its early gains, that would be quite a negative signal for risk assets in the near term.  There are many who believe we are in a bubble market, especially the tech sector, and certainly there are many frothy valuations there.  It would not be hard to imagine a correction happening just because.  But if a market falls on ostensibly bullish news, that correction could have a little more oomph than most would like to see.  I’m not saying this is my expectation, just that it is something to keep in mind.  As to the dollar, that remains beholden to the monetary policy choices and so far, they haven’t changed.

Good luck
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Annoyed

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Seems President Xi is annoyed
His stock market has been devoid
Of buyers, so he
Has banned, by decree
The strategies quant funds employed
 
But otherwise, markets are waiting
To see if inflation’s abating
The PCE print
Will give the next hint
If cuts, Jay will be advocating

 

Market activity remains on the quiet side of the spectrum as all eyes continue to focus on the Fed, and by extension all central banks.  As an indication, last night the RBNZ left their OCR rate on hold, as widely expected, but sounded less hawkish in their views, dramatically lowering the probability that they may need to hike rates again.  Prior to the meeting, there was a view hikes could be the case, but now, cuts are seen as the next step.  The upshot is the NZD fell -1.2% as all those bets were unwound.  One of the reasons this was so widely watched is there are some who believe that the RBNZ has actually led the cycle, not the Fed, so if hikes remained on the table there, then the Fed may follow suit.  However, at this stage, I would say all eyes are on tomorrow’s PCE print for the strongest clues of how things will evolve.

Before we discuss that, though, it is worth touching on China, where last night “unofficially” the Chinese government began explaining to hedge funds onshore that they could no longer run “Direct Market Access” (DMA) products for external clients.  This means preventing new inflows as well as winding down current portfolios.  In addition, the proprietary books using this strategy were told they could not use any leverage.  (DMA is the process by which non broker-dealers can trade directly with an exchange’s order book, bypassing the membership requirement, and in today’s world of algorithmic trading, cutting out a step in the transaction process, thus speeding things up.)  

Apparently, this was an important part of the volume of activity in China, but also had been identified as a key reason the shares in China have been declining so much lately.  Last night was no exception with the Hang Seng (-1.5%) and CSI 300 (-1.3%) both falling sharply and the small-cap CSI 1000 falling a more impressive -6.8%.  Once again, we need to ask why the CCP is so concerned about the most capitalist thing in China.  But clearly, they are.  I suppose that it has become a pride issue as how can Xi explain to the world how great China is if its stock market is collapsing and investment is flowing out of the country.  This is especially so given the opposite is happening in their greatest rival, the US. 

But back to PCE.  It appears that this PCE print has become pivotal to many macroeconomic views.  At least that is the case based on how much discussion surrounds it from both inflation hawks and doves.  As of now, and I don’t suppose it will change, the current consensus view of the M/M Core PCE print is 0.4% with a Y/Y of 2.8%.  As can be seen from the below chart from tradingeconomics.com, this will be the highest print in a year, and it would be easy to conclude that the trend here has turned upwards.

Of greater concern, though, is the idea that just like we saw the CPI data run hotter than expected earlier this month, what if this number prints at 0.5%?  Currently, the inflation doves are making the case that the trend is lower, and that if you look at the last 3 months or 6 months, the Fed has already achieved their target.  Their answer is the Fed should be cutting rates and soon.  For them, a 0.5% print would be much harder to explain and likely force a rethink of their thesis.

On the other side of the coin, the inflation hawks would feel right at home with that type of outcome and continue to point to the idea that the ‘last mile’ on the road back to 2.0% is extremely difficult and may not even be achievable without much tighter policy.  While housing is a much smaller part of the PCE data than the CPI data, remember, CPI saw strength throughout the services sector and that will be reflected.

One thing to consider here is the impact a hot number would have on the Treasury market.  Yields have already backed up from their euphoric lows at the beginning of the month by nearly 50bps.  Given the recent poor performance in Treasury auctions, where it seems buyers are demanding higher yields, if inflation is seen to be rising again, we could see much higher yields with the curve uninverting led by higher 10-year yields.  I’m not saying this is a given, just a risk on which few are focused.  In the end, tomorrow has the chance to be quite interesting and potentially change some longer-term views on the economy and the market’s direction.

But that is tomorrow.  Looking overnight, while Chinese stocks suffered, in Japan, equity markets were largely unchanged.  In Europe this morning, there is more weakness than strength with the FTSE 100 (-0.7%) and Spain’s IBEX (-0.7%) leading the way lower although other markets on the continent have seen far less movement.  As to US futures, at this hour (8:00), they are softer by about -0.3%.

In the bond market this morning, Treasury yields have fallen 2bps, while yield declines in Europe have generally been even smaller, mostly unchanged or just -1bp.  The biggest mover in this space was New Zealand, where their 10-year notes saw yields tumble 9bps after the aforementioned RBNZ meeting.

Oil prices (-0.3%) are giving back some of their gains yesterday, when the market rallied almost 2% on stories that OPEC+ was getting set to extend their production cuts into Q2.  It is very clear that they want to see Brent crude above $80/bbl these days.  In the metals markets, while precious metals are little changed, both copper and aluminum are softer by about -0.5% this morning.  I guess they are not feeling any positive economic vibes.

Finally, the dollar is much firmer this morning against pretty much all its counterparts.  While Kiwi is the laggard, AUD (-0.7%), NOK (-0.7%) and CAD (-0.4%) are all under pressure as well.  The same is true in the EMG bloc with EEMEA currencies really suffering (ZAR -0.5%, HUF -0.7%, CZK -0.4%) although there was weakness in APAC overnight as well (KRW -0.4%, PHP -0.6%).

On the data front, this morning brings the second look at Q4 GDP (exp unchanged at 3.3%), the Goods Trade Balance (-$88.46B) and then the EIA oil inventory data.  We also hear from Bostic, Collins and Williams from the Fed around lunchtime.  Yesterday’s data was generally not a good look for Powell and friends as Durable Goods tanked, even ex-transport, while Home Prices rose even more than expected to 6.1% and Consumer Confidence fell sharply to 106.7, well below the expected 115 reading.  

As we have been observing for a while now, the data continues to demonstrate limited consistency with respect to the economic direction.  Both bulls and bears can find data to support their theses, and I suspect this will continue.  With that in mind, to my eye, there are more things driving inflation higher rather than lower and that means that the Fed seems more likely to stand pat than anything else for quite a while.  Ultimately, I think we will see the ECB and BOE decide to ease policy sooner than the Fed and that will help the dollar.

Good luck

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Not Much Mystique

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In looking ahead to this week
Eleven Fed members will speak
And Core PCE
On Thursday, we’ll see
But otherwise, not much mystique
 
And one other thing we will hear
Is maybe a shutdown is near
But history shows,
And everyone knows,
Investors, this problem, don’t fear

 

After a dull session on Friday across all markets, the weekend delivered exactly zero new information that might alter investor perspectives.  Hence, we are in the same place we left things before the weekend.  Of more concern for traders, although not for hedgers or investors, is that there are few potential catalysts on the horizon for at least the first part of the week.  Thursday’s Core PCE data is clearly the biggest data release, but there will be ample time to discuss that as we get closer.

In the meantime, based on everything we have seen of late; the entire narrative will remain focused on NVIDIA as well as AI in general in the stock market.  For bond junkies, there will be more questions about the sustainability of the current spending plans in the US and whether the market will absorb all the issuance that is coming.  Planned this week are auctions for $398 billion of T-bills, 2-year, 5-year, and 7-year notes.  That’s a lot of issuance, and there is no sign that it is going to slow down at any point in the near future.  Last week, the 20-year bond auction had its worst outcome in its history, with a 3.3bp tail, an indication that investors are getting full or at the very least concerned in some manner and need higher yields to be persuaded to continue investing. 

The issue here stems from the fact that interest payments are utilizing an increasing part of the Federal budget and as old debt matures and is rolled over at current yields, those payments will continue to grow.  While theoretically, the Treasury can simply continue to issue more debt in order to pay off whatever comes due, that means the stockpile of debt continues to grow, and with it, the interest needed to be paid each year.  Alternatively, the Fed can change their QT back to QE, purchase Treasury securities and cap rates or drive them lower.  However, if Powell goes down that road, the results are very likely to be a serious uptick in inflation and a serious decline in the dollar.  The point is the current pace of issuance is not sustainable in the long run.  Although, to be fair, people have been saying the same thing about Japan for the past twenty years, so it could still go on for a while.

I continue to believe that a bear-steepening outcome is the most likely, with bond yields rising above current the Fed funds target and the excessive supply of new bonds is one of the things driving that view.  However, that seems more like a late summer or autumnal issue, not something for right now.

But away from the bond discussion, there is little else to note.  A quick recap of the overnight session shows that Asian equity markets were on the sleepy side with Japan up a bit, 0.4% or so, while Chinese shares resumed their longer-term trend declines with the Hang Seng (-0.5%) and CSI 300 (-1.0%) both ceding ground, as there were no new stimulus programs announced.  It is seeming increasingly as though absent stimulus; Chinese shares are a sale.  In Europe, the action is mixed with both gainers and losers but nothing moving very far at all, 0.3% being the largest change on the day.  It is the same story in the US, with futures at this hour (7:30) basically unchanged from Friday’s closing levels.

In the bond market, Treasury yields (-1bp) are edging lower this morning, although we are seeing the opposite tendency in Europe with most sovereigns gaining 1bp in yields.  The outlier here is the UK, where 10-year Gilts have seen yields climb 6bps after a better-than-expected CBI Retail Sales print added to the Flash PMI data from last week and is pointing to a somewhat better economic outlook.  A quick look east shows that JGB yields slipped 3bps overnight as investors, looking ahead to tonight’s CPI data are expecting a soft print and less incentive for the BOJ to tighten policy.

Oil prices (-0.6%) continue to slide slowly as production continues apace but there are questions about demand given the weakness seen in Europe, the UK and China.  A stronger US economy is not enough, by itself, to drive oil prices higher.  In the metals markets, copper is the big loser, down -1.4%, as concerns over Chinese economic resurgence continue to dog the red metal.  It appears the relationship between copper and the CSI 300 is tightening up a bit.

Finally, the dollar is under modest pressure this morning as US yields continue to soften slightly after Friday’s decline.  But to indicate just how modest things are, the biggest mover today is the euro (+0.3%).  Literally every other major currency, whether G10 or EMG has had less movement than that.  In other words, there is no story here.  We need to see some monetary policy changes before this is going to heat up again.

On the data front, as indicated above, it is a pretty quiet week as follows:

TodayNew Home Sales680K
 Dallas Fed Manufacturing-8.0
TuesdayDurable Goods-4.5%
 -ex transport0.2%
 Case Shiller Home Prices6.0%
 Consumer Confidence115
WednesdayQ4 GDP3.3%
ThursdayInitial Claims210K
 Continuing Claims1874K
 Personal Income0.4%
 Personal Spending0.2%
 PCE0.3% (2.4% Y/Y)
 Core PCE0.4% (2.8% Y/Y)
 Chicago PMI48.0
FridayISM Manufacturing49.5
 ISM Prices Paid53.0
 Michigan Sentiment79.6
Source: tradingeconomics.com

Looking at everything, although there seems to be a lot of stuff, most of it is just not really that important.  I have to remark on the Case Shiller data as recall, a big piece of the disinflation theory is the decline in housing prices.  A 6.0% Y/Y print does not feel like it is declining to me, but then I am just an FX poet.  Obviously, all eyes will be on the PCE data Thursday morning.  In addition to this, we hear from eleven different Fed speakers including Waller and Williams, two of the more important voices, although Chairman Powell remains mum.

Nothing we have seen over the past weeks has changed my longer-term views and quite frankly, the first part of the week is shaping up as a sleeper.  Quiet markets are a boon to hedgers as executing is greatly eased, and banks will compete hard for your business.  In the end, the dollar continues to follow the yield story, so, if yields in the US slide from current levels, the dollar will likely follow.  The opposite is also true.

Good luck

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Not One Whit

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Both headline and core PCE
Were softer, with both below three
But under the hood
It’s not quite as good
As housing and transport are key
 
The narrative, though, will not quit
Assuring us all this is it
Rate cuts will come soon
And stocks to the moon
But so far, for proof, not one whit.
 
There is a very good analyst who writes regularly on the macroeconomic story named Wolf Richter.  In the wake of Friday’s PCE data release, he published an article that had the following table:

It is not hard to look at this table and see a bit of the reality we all face, rather than the widely touted headline numbers regarding inflation.  Housing continues to be sticky at much higher inflation rates than target, as well as transportation services, recreation services and financial services.  But even the other stuff, seems to be running above the elusive 2.0% level.  Now, this is the annualized rate of the past 6 months’ average readings.  But as I highlighted last week regarding CPI, this seems to be the new benchmark.  My point is that while the narrative is really working hard to convince us all that inflation is collapsing and the Fed is massively over-tight in its policy and needs to CUT RATES NOW, this breakdown doesn’t look quite the same.  My belief is the Fed remains on hold much longer than the market is expecting/hoping for, and that at some point, equity markets and risk assets are going to come to grips with that reality.  Just not quite yet.

Of course, maybe the narrative is spot on, and inflation is going to smoothly decline back to the 2% level while economic growth continues its recent above-trend course.  But personally, I have to fade that bet.  Based on the amount of continued fiscal stimulus, as well as the Fed’s discussion of slowing QT and their indication of rate cuts later this year, I believe that while the growth story is viable, it will be accompanied with much hotter inflation than is currently priced.  The fact that breakeven inflation rates are priced at 2.50% in the 10-year does not mean that is what is going to happen.  Just like the fact that the Fed funds futures market is currently pricing between 5 and 6 rate cuts in 2024 does not mean that is what is going to happen.  Let’s face it, nobody knows how the rest of the year is going to play out.  The one thing, however, of which we can be sure is that Treasury Secretary Yellen will spend as much money as possible in her effort to get President Biden re-elected.  That alone tells me that inflation is set to rebound.

And there is one other thing to remember, as things heat up in the Red Sea, and shipping avoids the area completely, the cost of transiting stuff from point A to point B continues to rise.  The cost is measured both in the dollars charged for the service and the extra 10-14 days it takes to complete the trip around the Cape of Good Hope in South Africa.  It seems that the Biden Administration’s foreign policy has unwittingly had a negative impact on its economic policy plans.  

In sum, when I look at both the data and the activities around the world, it remains very difficult to accept the narrative that inflation is collapsing so quickly that the Fed MUST cut rates and cut them soon.  The combination of still robust US growth on the back of excessive fiscal stimulus and the increased tensions in the oil market lead me to a very different conclusion.

With that in mind, let’s see what happened overnight.  Equity markets in Asia were mixed as Japan (Nikkei +0.8%) and Hong Kong (Hang Seng +0.8%) both rallied but mainland Chinese shares (CSI -0.9%) fell.  This was somewhat surprising as China, in their continuing efforts to prop up their stock markets, have restricted the lending of any securities for short sales while a HK court ruled Evergrande (remember them?) should be liquidated completely.  Perhaps the Chinese real estate situation is not quite fixed yet after all.  I suspect that we will see other liquidations as well before it is all over.  In the meantime, European bourses are mixed with the DAX (-0.4%) lagging while the FTSE 100 (+0.25%) is top dog today.  There’s been no news of which to speak so this seems like position adjustments ahead of the Fed’s activities later this week.  US futures, too, are mixed and little changed at this hour (7:15).

Bond markets, though, are really loving all the rate cut talk and are growing more confident that they will be coming soon as inflation collapses.  Treasury yields are lower by 3bps this morning and the entire European sovereign market has rallied with yields down an impressive 5bps-7bps today.  The only outlier is the JGB market, which saw the 10-year benchmark yield edge up 1bp.  It is much easier for me to believe that the ECB is going to cut as inflation in the Eurozone slows alongside the faltering growth story than to believe that the Fed is going to cut into an economy growing 3+%.  But that’s just me.

In the commodity markets, oil (+0.3%) continues to find support as the tensions in the Middle East expand after an attack in Jordan killed three US servicemen there.  Oil is higher by 5% in the past week and more than 11% in the past month.  It seems to me that will not help the inflation story.  At the same time, we are seeing demand for precious metals as gold (+0.5%) and sliver (+1.0%) are both rallying on the increased nervousness around the world.  Perhaps more interestingly is that copper is marginally higher this morning, something that would seem contra to the escalating tensions.

Finally, the dollar has rallied a bit this morning on net, although it is not a universal move by any stretch.  For instance, while European currencies are broadly weaker, in Asia and Oceania, we are seeing strength with AUD and NZD (both +0.4%) and JPY (+0.2%) fimer.  As to the rest of the world, it is a mixed session with minimal movement.  Feels like a wait and see situation given all the data and info coming this week.

Speaking of the data this week, there is much to absorb.

TodayTreasury Funding Amount$816B
 Dallas Fed Manufacturing-23
TuesdayCase Shiller Home Prices5.8%
 JOLTS Job Openings8.75M
 Consumer Confidence115
WednesdayADP Employment135K
 Treasury QRA 
 Employment Cost Index1.1%
 Chicago PMI48
 FOMC Meeting5.5% (unchanged)
ThursdayInitial Claims210K
 Continuing Claims1835K
 Nonfarm Productivity2.5%
 Unit Labor Costs1.7%
 ISM Manufacturing47.3
 Construction Spending0.5%
FridayNonfarm Payrolls173K
 Private Payrolls145K
 Manufacturing Payrolls2K
 Unemployment Rate3.8%
 Average Hourly Earnings0.3% (4.1% Y/Y)
 Average Weekly Hours34.3
 Participation Rate62.4%
 Factory Orders0.2%
 Michigan Confidence78.8

Source tradingeconomics.com

The first thing to understand is that this morning, the Treasury will be releasing how much funding they expect to need in Q1 of this year, currently expected at $816 billion, but Wednesday’s QRA will describe the mix of the borrowings.  Recall that last quarter, Secretary Yellen changed the mix of short-dated paper to long-dated coupons substantially and completely reversed the bond market rout that was ongoing at the time.  If she continues to issue far more bills than coupons, it should support the bond market and help continue to juice risk assets.  Any substantial increase in coupon issuance is likely to be met with a significant stock and bond market sell-off.  So, which do you think she will do?

Otherwise, looking at the other data, certainly there is no indication that housing prices are moderating.  The Fed will not change rates on Wednesday, but everyone is waiting to see if they will remove the line in their statement about potentially needing to raise rates going forward.  Perhaps there will be a little two-step where the QRA points to more bond issuance, but the Fed sounds more dovish to offset that news.  And of course, Friday’s NFP data will be keenly watched by all observers as any signs that the labor market is cracking will get the rate cut juices flowing even faster.

All in all, we have a lot of new information coming to our screens this week.  At this point, it is a mug’s game to try to guess how things will play out.  However, if we see dovishness from the Fed or the QRA (more bill issuance) then I expect risk assets to perform well and the dollar not so much.  The opposite should be true as well, a surprisingly hawkish Fed or more coupon issuance will not be welcomed by the bulls, at least not the equity bulls.  The dollar bulls will be happy.

Good luck

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Smokin’

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The GDP number was smokin’
As animal spirits have woken
The Core PCE
If higher than three
Could slay rate-cut talk that’s been spoken

Thus, if the Fed’s data dependent
The ‘conomy’s truly resplendent
So, please do explain
Why rate cuts are sane
Seems rates ought, instead, be ascendent

By now you are all aware that Q4 GDP was a significantly better than expected 3.3% SAAR, far above the 2.0% analyst forecasts and far above the Atlanta Fed’s GDPNow readings.  For everyone who is looking for that recession, thus far it still appears to be somewhere further down the road.  At some point, it is certain, there will be a recession but the when is the big question.

Now, a different question would be what is driving the economic activity that we have seen?  That answer is far easier to determine as in the equation that defines economic growth: Y=C+I+G+NX (exports-imports), the variable that is growing most consistently is the G, government spending. Simply look at the size of the budget deficit. This is not to say that government spending is not growth as measured, just that it is not organic growth that feeds on itself.  It is the organic kind that is the sign of a healthy economy.  Government spending can be analogized as gaining weight but not growing stronger, i.e. getting fat.

Regardless, though, of the reasons for the growth, it is real in the sense that more activity is taking place.  This implies that demand continues to be robust.  Since this is the case, I would ask all those who are expecting the Fed to cut rates by May at the latest, but begging for a March rate cut, why do you think that is appropriate?

First off, another way to say data dependent is to call the Fed reactive.  This means that the Fed is explicitly going to be behind the curve and react to the data they see, they are not going to pre-empt expectations for future economic outcomes.  Back in the day, when Alan Greenspan was Fed chair, he would raise rates occasionally to head off what he thought was incipient inflation, but rate cuts were then, and have always been, reactive to problems in the economy.  That is why, generally, rate decline much faster than the rise.  This cycle was quite the exception but then Chairman Powell was in denial for a very long time before he figured out he had made a mistake.  It is this reason that I believe the Fed funds outcome is bimodal, that either there will be only one or two token cuts, or we will see 300bps or more as the economy craters.  Based on yesterday’s data, I’m still in the one cut camp this year as per my 2024 forecasts.

It is important to remember that the Fed’s dot plot is not the road map, per se, it is merely a compilation of each member’s individual forecasts.  But they are just that, forecasts, and as we saw with yesterday’s GDP number, FORECASTS ARE WRONG ALL THE TIME!  There is no reason to believe the Fed or its members, who have an atrocious forecasting record, know where things are going to be later this year, let alone in 2025 or 2026.

Back to my point, to drive it home; the Fed has explained they are going to be reactive to the data when it comes to setting policy rates.  So far, the data is pointing to continued solid, above trend, economic growth and the employment situation remains strong (Initial Claims at 200K, Unemployment Rate at 3.7%).  As well, inflation remains well above their target.  Once again, I will ask, why will they be cutting rates in H1?  If they do, it implies that things have gotten a whole lot worse in a hurry, and that, my friends, will not be a positive for risk assets.

Turning to the overnight session, after a solid equity market performance in the US, where all three major indices rallied a bit, Asia took a different path as both Japanese and Chinese shares fell 1.35% or more.  Apparently, the luster of the Chinese fiscal and market support has faded a bit, but that hasn’t stopped those who got long Japanese shares in that pairs trade I discussed yesterday, from continuing to sell.  Interestingly, the data overnight showed that Tokyo CPI, on every measure, was much softer than forecast implying that the BOJ has far less need to consider tightening policy in the near future.  I would have thought that would have helped Japanese shares, but not so much.  Europe, though, is having a much better day with the CAC (+2.1%) leading the way on the back of very strong results by LVMH, the luxury goods firm.  But all the indices are higher on the continent.  Alas, US futures are a bit softer at this hour (7:00), but only just and really it is the NASDAQ which has been lagging a bit.

In the bond market, activity has been muted everywhere as investors and traders around the world await this morning’s PCE data in the US.  Treasury yields, which slid a few bps yesterday, are unchanged on the day and European sovereigns are all seeing yields drift lower by between 1bp and 3bps.  Perhaps the least surprising move is JGB yields sliding 3bps overnight on the back of that Tokyo CPI data.  As an indication of what those numbers are like, Headline and Core both printed at 1.6% Y/Y, significantly below the December readings and the lowest in nearly two years.

While oil prices have backed off a bit this morning, -0.8%, they have had an excellent week, up nearly 5% on the back of the stronger showing in the US economy, the fiscal stimulus stories in China and the fact that Ukraine was able to successfully attack a Russian oil shipping facility, closing it down and reducing supply.  In the short-term, it does feel like there are more potential catalysts to drive this price higher, but the long-term question remains open.  As to the metals markets, they continue to do very little with marginal gains or losses on a day-to-day basis as we have been trendless in gold and copper for the past several months.  We will need to see some fundamental changes in the supply/demand equation to shake out of this lethargy, but that remains true in many markets.  Data of late is a Rorschach test as there always seems to be a data point to help someone justify their view, regardless of their view.  We need to see things align more clearly for a change in either direction.

Finally, the dollar, which has been grinding ever so slightly higher over the past month or two, is a bit softer overall this morning, roughly 0.3% across the board in both the G10 and EMG blocs.  Arguably, the most important data overnight was that Tokyo CPI, but the yen is actually unchanged on the session, lagging the euro and pound, but not responding very much.  Interestingly, despite oil’s decline, NOK is slightly firmer, so this is really a modest dollar weakness story for now.  Perhaps in anticipation of a soft PCE number?

So, let’s turn to the data today.  Everything comes at 8:30 and here are the consensus views right now: Personal Income (0.3%), Personal Spending (0.4%) PCE (0.2% M/M, 2.6% Y/Y), and most importantly, Core PCE (0.2% M/M, 3.0% Y/Y).  Much has been made of comments that Governor Waller made a few weeks ago which have been interpreted as ‘knowledge’ that the M/M number would be soft, 0.1%, dragging all the other indicators with it.  As well, Treasury Secretary Yellen ostensibly explained that the recession has been avoided and the soft landing achieved so inflation is no longer a problem.  And maybe that will be the case.  But inflation is a funny thing.  It is insidious and extremely difficult to remove from an economy as complex as the United States once it is embedded there.  I have no idea where today’s data will print, but I will say that my bias is that inflation is stickier than the rate cut advocates believe.

As to the market reaction, that is also very difficult to anticipate.  Yesterday in my assessment of what would occur in response to a hot number, I was right about the dollar and oil, but not about stocks and bonds, both of which rallied.  As of now, the Fed funds futures market continues to price a 50:50 chance of a March cut.  I feel like we will need to see a very soft number today to keep that stable.  And if the M/M number is 0.3%, I would expect that March probability to shrink rapidly.  However, for now, those looking for rate cuts remain on top in the game, and they will only give up their views kicking and screaming.  Keep your ears peeled.

Good luck and good weekend
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Possibly Soaring

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

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

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

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

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

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

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

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

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

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

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

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

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

Good luck
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With Conceit

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On Friday, two final Fed speakers
Explained they are both simply seekers
Of lower inflation
Hence, justification
That they’re simply policy tweakers
 
We now have nine days til they meet
When both bulls and bears will compete
To offer their vision
While casting derision
On each other’s views with conceit
 
It appears to be a slow day to start what has the potential for quite an interesting week.  While the Fed is in their quiet period, we have central bank meetings in Japan, the Eurozone, Norway and Canada as well as the first look at Q4 GDP and the all-important December PCE data.  As I said, while it is slow today, there is much to anticipate.

But first let’s finish up last week, where the equity rally continued unabated despite continued pushback from Fed speakers.  Notably, SF’s Mary Daly, who is usually a reliable dove, was very clear that it is too soon to consider cutting interest rates.  Her exact words, “We need to see more evidence that it is heading back down to 2% consistently and sustainably for me to feel confident enough to start adjusting the policy rate,” seem pretty clear that she is not ready for a cut yet.  Meanwhile, Chicago’s Austan Goolsbee was similarly confident that it is premature to consider cutting rates any time soon.  

Arguably, of more importance is the fact that the Fed funds futures market is now pricing in slightly less than a 50% probability of a rate cut in March and about 5 rate cuts this year, rather than the 6 to 7 cuts that were in the price ten days ago.  So, we heard a great deal of jawboning to remove just one rate cut from the market perception.  For the life of me, I cannot look at the recent CPI data as well as the situation in the Red Sea and the Panama Canal, where though caused by different situations, show similar outcomes in forcing a significant amount of shipping volumes to change their route to a longer, more costly one and see lower inflation in our future.  I understand that there was a disinflationary impulse, but to my eye that has ended.

Now, it is entirely possible that we see the rate of inflation decline on the back of a recession, but that is not the market narrative at this point.  Rather, the market appears to be priced for the perfection of a soft landing, where the Fed will be able to tweak rates lower while inflation continues to soften, and unemployment remains low.  Alas, I still see that as a pipe dream.  As I have written in the past, it seems far more likely that we see either one rate cut as the economy continues to perform and inflation remains stubborn or 10 or more amidst a sharp slowdown in economic activity and rising unemployment, but five doesn’t seem correct to me.

In the meantime, today is a waiting game for all the things yet to appear this week.  Looking at the overnight activity, we continue to see the dichotomy between China and Japan with the former seeing its equity markets continue to crater (CSI 300 -1.6%, Hang Seng -2.3%) while the latter has made yet another new 34 year high (Nikkei +1.6%).  Last night, the PBOC left their key Loan Prime Rates unchanged, as expected, but still a disappointment to a market that is desperate for some stimulus from the government there.  So far, all the activity has been directly in the financial markets where the Chinese have banned short-selling and “advised” domestic institutions to stop selling any equities, and yet the markets there continue to underperform.  Perhaps President Xi will decide that common prosperity requires fiscal stimulus of a significant nature, but that has not yet been the case.  Both the Hang Seng and mainland markets have fallen precipitously, but there is no obvious end game yet.  Meanwhile, European bourses are all in the green, on the order of 0.5% while US futures are higher by a similar amount at this hour (7:45).

Bond markets are having a better day around the world today with yields falling everywhere.  Treasury yields are the laggard, only down by 3bps, while European sovereigns have fallen 5bps and even JGB’s fell 1 bp overnight.  Perhaps it is the sterner talk by central bankers regarding rate cuts (ECB speakers have also pushed back hard on the idea that rate cuts are coming in March, with the June meeting the favorite now), which has investors becoming more comfortable that inflation will continue its recent declines.  As there has been exactly zero data released today, that is the most rational explanation I can find.

In the commodity markets, quiet is the word here as well with oil (+0.35%) edging higher, thus holding onto last week’s gains, while metals markets are mixed.  Gold is unchanged on the day; copper is modestly softer, and aluminum is modestly firmer.  As has been the case for the past several weeks, there is not much information to be gleaned from these markets right now.  I expect that over time, we will see commodity prices trade higher as the decade long lack of investment in the sector plays out, but in the short-term, there is little on which to see regarding price trends, absent a major uptick in the Middle East dynamics.  After all, even avoiding the Red Sea hasn’t had much impact.

Lastly, the dollar is mixed overall.  Against its G10 counterparts, JPY, GBP and NZD all have edged higher by about 0.2%, but we are seeing similar weakness in NOK and AUD.  In the EMG bloc, we actually see a few more laggards than leaders with ZAR (-0.8%), HUF (-0.5%), and KRW (-0.4%) all suffering a bit on the session while CLP (+0.5%) is the leading light in the other direction.  Ultimately, the big picture here remains the dollar is tied to the yield story and if the Fed really does maintain higher for longer, the dollar will find support.

As mentioned above, there is a lot of data to digest this week as follows:

TuesdayBOJ Rate Decision-0.1% (unchanged)
WednesdayFlash Manufacturing PMI48.0
 Flash Services PMI51.0
 Bank of Canada Rate Decision5.0% (Unchanged)
ThursdayNorgesbank Rate Decision4.5% (Unchanged)
 ECB Rate Decision4.0% (Unchanged)
 Durable Goods1.1%
 Q4 GDP2.0%
 Chicago Fed National Activity0.03
 Initial Claims200K
 Continuing Claims1828K
FridayPersonal Income0.3%
 Personal Spending0.4%
 PCE0.2% (2.6% Y/Y)
 Core PCE0.2% (3.0% Y/Y)

Source: tradingeconomics.com

So, the end of the week is when we get inundated, although the Eurozone Flash PMI data comes on Wednesday as well.  But without a major data miss, all eyes and ears will be on the central banks right up until we see Friday’s PCE data.  Regarding that, there is a growing expectation that the core number will be quite soft, with many pundits calling for an annual number below 3.0% on the core reading.  However, given what we have seen from inflation readings everywhere, including the slightly hotter than forecast CPI numbers, I would fade that view.

The one thing of which I am confident is that if the Core PCE print is soft, you can expect the futures markets to price 6 or 7 cuts into this year and more cuts everywhere with the concomitant rise in both stock and commodity prices, especially given the Fed’s inability to push back immediately.  However, my view is that the world of today is not the world of the past 15 years, and that higher inflation and higher interest rates are an integral part of the future.  As well, unless there is a financial crisis of some sort, where more banks are under pressure like last March, I remain in the very few rate-cuts camp and think the equity rally has an expiry date before the summer.  As to the dollar, I think it holds up well in that circumstance.  While I changed my view based on the Powell pivot at the December FOMC meeting, the data has not backed him up, at least not yet.

Good luck

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