Tag Archives: #Powell

Threw in the Towel

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There once was a banker named Powell
Who fought, prices, high with a growl
Then going got tough
So he said, “enough”
And basically, threw in the towel
 
His problem’s inflation’s alive
And truthfully, starting to thrive
The worry is he
Will soon say that three
Percent’s the rate for which he’ll strive

 

With several days to digest the latest FOMC meeting results, and more importantly, the Powell press conference, my take is the Chairman recognizes that to get to 2.0% is going to be extremely painful, too painful politically during this fraught election cycle.  And so, while he tried very hard to convince us all that the Fed was going to get to 2.0%, he stressed it will “take time”.  The subtext of that is, it’s not going to happen in the next several years, at least, and this poet’s view is it may not happen again for decades.  The key to recognizing this subtle shift is to understand that despite increased forecasts for both growth and inflation, the Fed remains hell-bent on cutting interest rates.  Even the neo-Keynesian views which the Fed follows would not prescribe rate cuts in the current economic situation.  But rate cuts are clearly on the table, at least for now.

This begs the question, why is he so determined to cut interest rates with the economy growing above trend?  At this stage, the explanation that makes the most sense to me is…too much debt that needs to be refinanced in the coming years.

Consider, current estimates for total debt around the world are on the order of $350 trillion.  That compares to global GDP of just under $100 trillion.  Many estimates indicate that the average maturity of that debt is about 5 years which means that something on the order of $70 trillion of debt needs to be refinanced each year.  Now, the US portion of that debt is estimated at about $100 trillion, of which ~$34.5 trillion is Treasury debt, and the rest is made up of corporate, mortgage, municipal and private debt.  Remember, too, that total US GDP is currently about $28 trillion as of the end of February (according to the FRED database from the St Louis Fed), so the ratio here is similar to the global ratio.  [Note, this does not include unfunded mandates like Social Security and Medicare, just loans and bonds outstanding.]

Here’s the problem, we have all heard about the fact that the US debt service has climbed above $1 trillion per annum and given the underlying principle is growing, that debt service is growing as well.  In addition, on the private side, there is a huge proportion of corporate debt that has become a serious problem for banks and investors, notably the loans made for commercial real estate, but personal and credit card debt as well.  The Fed cannot look at this situation and conclude that higher rates, or even higher for longer, is going to help all the debtors.  And if the debtors default…that is going to be an economic disaster of epic proportions.Add it up and the only logical answer is Powell is going to gaslight everyone with the idea that the Fed is going to remain vigilant regarding inflation.  And they will right up until the time when the pain becomes too great, or too imminent and they cut.  I think that we are seeing the first signals from markets this is going to be the case from both gold and bitcoin.  But if I am correct, and the Fed cuts despite still elevated inflation readings, look for the dollar to decline sharply, at least initially until other central banks cut as well, look for bonds to fall sharply and look for hard assets to rally.  As to stocks, I expect that initially it will be seen as a positive and juice the rally, but that over time, stocks will begin to lag hard assets.  Quite frankly, this looks like it is a 2024 event, so perhaps if that first cut really comes in June, the summer is going to be far more interesting than anybody at the Fed would like to see.

Kanda told us all
“We are always prepared” to
Prevent yen weakness
 
Meanwhile in Beijing
The central bank responded
Nothing to see here

 

“The current weakening of the yen is not in line with fundamentals and is clearly driven by speculation. We will take appropriate action against excessive fluctuations, without ruling out any options.”  So said Masato Kanda, the current Mr Yen at the MOF.  It seems possible, if not likely, the yen’s decline in the wake of the BOJ move last week came as a bit of a surprise.  This morning, the yen (+0.1%) has edged away from its lows from last week, but USDJPY remains above the 151 level and very close to the level when the MOF/BOJ intervened in October 2022.  Adding to the pressure was Friday’s very surprising sharp decline in the CNY, which many in the market took to mean the PBOC was comfortable with a weaker yuan. 

Economically, a weaker yuan seems to make sense, but the PBOC’s concern is that it could lead to increased capital outflows, something which they are desperate to prevent.  As such, last night, the CNY fixing was nearly 1200 points stronger than expected, with the dollar rate below 7.10, and we saw significant dollar selling by the large Chinese banks.  Apparently, Friday’s movement was a bit too much.  I suspect that these two currencies will continue to track each other at this point with both currently at levels which, in the past, have been demarcation lines for intervention.   

Here’s a conspiratorial thought, perhaps the Fed’s dovishness is a response to the weakness in the yen and Powell’s best effort to help the BOJ avoid having to intervene again.  The thing about intervention is it, by definition, represents a failure of monetary policy, at least in the market’s eyes.  And in the end, all G10 central banks are in constant communication.

Ok, let’s survey the markets overnight.  All the currency activity seemed to put a damper on equity investors as Asia saw weakness across the board with Japan (Nikkei -1.2%) falling, although still above 40K, and both Hong Kong and mainland shares in the red.  In Europe this morning, red is also the predominant color, although the declines are more muted, ranging from -0.1% (DAX) to -0.4% (CAC).  Finally, US futures, at this hour (7:00) are also slipping lower, down 0.25% on average.

In the bond market, Treasury yields are backing up 3bps this morning, bouncing off the critical 4.20% technical level again.  As well, in Europe, sovereign yields are rising between 2bps and 3bps across the board.  There has been no data of note, but we have heard a bit more from ECB bankers with a surprising comment from Austria’s Holtzmann that he saw no reason for rate cuts at all.  That is an outlier view!  And despite what is happening in the FX markets, JGB yields remain unchanged yet again.

Turning to commodities, oil (+0.3%) is edging higher this morning as, after a strong rally early in the month and a small correction, it appears that $80/bbl is a new floor for the price.  In the metals markets, after last week’s pressure lower, this morning both precious (gold +0.3%) and base (copper +0.1%) metals are edging higher.  There has not been much in the way of news driving things in this session.

Finally, the dollar is a touch softer this morning, but that is after a strong week last week.  We’ve already touched on the Asian currencies, and it is true the entire bloc, which had been under pressure, is a bit stronger this morning.  But we are seeing strength across the board with G10 currencies higher on the order of 0.2% and most EMG currencies firmer by between 0.1% and 0.2%.  So, while the movement is broad, it is not very deep.  I maintain this is all about US yields and the fact that despite Powell’s newfound dovishness, the Fed remains the tightest of the bunch.

On the data front, there is a lot of information to be released, but I suspect all eyes will be on Friday’s PCE data.  

TodayChicago Fed Nat’l Activity-0.9
 New Home Sales680K
TuesDurable Goods1.0%
 -ex Transport0.4%
 Case Shiller Home Prices6.8%
 Consumer Confidence106.7
ThursdayInitial Claims215K
 Continuing Claims1808K
 Q4 GDP3.2%
 Chicago PMI46.0
 Michigan Sentiment76.5
FridayPersonal Income0.4%
 Personal Spending0.4%
 PCE0.4% (2.4% Y/Y)
 Core PCE0.3% (2.8% Y/Y)
Source: tradingeconomics.com

In addition to that menu, Fed speakers will be about with five scheduled including Chairman Powell on Friday morning.  Remember, too, that Friday is a holiday, Good Friday, with market liquidity likely to be somewhat impaired as Europe will be skeleton staffed.  As well, it is month end, so my take is if Powell veers from the script, or perhaps reinforces the dovish theme, we could see an outsized move.  Just beware.

Recent activities by the BOJ and PBOC indicate that the market has found a sore spot for the central banks.  If the data this week doesn’t cooperate, meaning it remains stronger than forecast, it will be very interesting to hear what Chairman Powell has to say on Friday.  Cagily, he speaks after the PCE data, so he will be able to respond.  But especially if that data comes in hot, we are likely to see more volatile markets going forward.  However, today, it is hard to get too excited.

Good luck

Adf

The Dollar is King

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The Old Lady left rates on hold
But two members changed views when polled
No longer did they
See hikes as the way
The outcome was pounds were then sold

In fact, the most noteworthy thing
Is watching the dollar’s upswing
Against all its foes
Its value has rose
And once more the dollar is king

Finalizing the commentary on central bank activity this week, while the BOE did not adjust its rates, as was universally expected, the excitement came when the votes were tallied up.  As I had mentioned on Monday, at the last meeting, the split was 1/6/2 for a cut, holding steady and a hike respectively.  It remains amazing to me that members of the committee could have viewed the data and come to completely opposite conclusions in the past.  But the big change was that the two members who had been consistently voting for a hike adjusted their view to holding steady with the outcome a single vote for a cut and the rest of the committee voting to keep policy unchanged.  Of course, in the world in which we live today, that was tantamount to a rate cut and seen as quite dovish with the result being the pound underperformed its peers and continues to do so this morning, falling another -0.6%.  The developing narrative here is that a rate cut is coming soon to the UK, certainly by the June meeting, even though inflation remains far above the BOE’s target.  Yes, the inflation readings earlier this week were a bit softer than forecast, but they are still running at 4.5% at the core level.

Arguably, the more amazing thing is that the narrative around the US seems to have subtly shifted despite Powell’s quite dovish tone at the press conference.  I have seen several analyses that indicate expectations are growing for other central banks to ease policy before the Fed.  Perhaps it was the SNB’s bold action yesterday that got people thinking the rest of the world wouldn’t wait for Powell.  Or perhaps, the punditry who push the narrative are finally considering the fact that the US economy continues to be the best performing one around with the least need for further stimulus.  For instance, yesterday’s US data showed softer than expected Unemployment Claims, higher than expected Home Sales with a huge jump in the average price, better than expected Philly Fed and better than expected Flash PMI data.

Whatever the driver, analysts all over are discussing the relative hawkishness of Powell vs. his central bank brethren.  The good news is that we will get to hear from the man himself again this morning at 9:00am so perhaps he will clarify the situation.

FWIW, which is probably not that much, I remain incredulous that the Fed can even consider cutting rates in the near future.  The data are certainly indicating that economic activity remains strong, and we have seen an increase in pricing pressures discussed in a number of the surveys, like yesterday’s Philly Fed and PMI.  As long as unemployment remains quiescent, and we don’t have a major banking catastrophe it is unclear what the motivation behind cutting rates would be on an economic basis.  And consider for a moment that home prices yesterday rose 5.7%, another dagger in the heart of the idea that the shelter component of inflation measures is going to decline.  Let’s see what he says.

Until then, a look at the overnight session shows a mixed picture after yet another record setting day in US equity markets yesterday.  Japan is keeping pace, holding on to its recent gains and drifting higher but Chinese shares had a very tough time, with the Hang Seng (-2.2%) leading the way lower while mainland shares (CSI 300-1.0%) fell as well.  Throughout the rest of the region, the tale was an amalgam of gainers (India, Taiwan, New Zealand) and losers (South Korea, Australia).  In Europe, the UK (+0.8%) is the best of the bunch after posting stronger than expected Retail Sales data, although the Y/Y numbers there are still negative.  But the change was good.  However, on the continent, it is also an amalgam of gainers (Italy, Spain, Germany) and losers (France, Greece) as despite comments from Bundesbank president Nagel that a cut was coming in June, excitement remains lacking.  US futures at this hour (7:30) are essentially unchanged.

The bond market has been a bit more positive with yields sliding across the US (2bps) and all of Europe (between 1bp and 4bps) as investors prepare for the initial move by the ECB.  JGB yields are unchanged as any idea that the BOJ’s recent action was the starting signal for a rush higher in interest rates have been completely quashed.  Perhaps the one area where there is more anticipation is in China, which has seen a very consistent decline in yields for the past year with the 10-year there now sitting at 2.3%, a historic low.  However, despite that, there are many analysts looking for further policy ease by the PBOC and the potential for yields to decline even further.

Oil prices (+0.1%) while essentially unchanged this morning are consolidating losses from the past three sessions which were driven by an increase in chatter about a ceasefire in Gaza.  At the same time, we continue to see net drawdowns of inventories as reported by the EIA which is typically a sign of future strength in the price.  After a great run, gold (-0.6%) and copper (-1.0%) are both under pressure this morning, a situation I attribute entirely to the dollar’s broad strength.

Finally, turning to the dollar, OMG it is ripping higher today.  Versus its G10 counterparts, it is nearly universal with the euro (-0.4%), AUD (-0.8%) and the Scandies (SEK -0.9%, NOK -0.95%) all under pressure.  The only currency not declining is JPY, which is flat on the day but remains at its recent lows (dollar highs) well above 151.50.  in the EMG space, ZAR (-1.15%) is leading the way lower, but the real surprise is CNY (-0.8%) a huge move for a currency with 5% volatility, as it appears the PBOC has stepped away from its efforts to support the currency.  Given the huge rate differential with the dollar, by rights, we would expect USDCNY to be closer to 7.50 than its current level of 7.28, and I expect it will continue to move in that direction.  Watch carefully, especially if/when the PBOC reduces the Reserve Ratio Requirement again in the next several months.

At any rate, you get the idea that the dollar is top of the charts today, ultimately on this renewed narrative of a relatively hawkish Fed versus relatively dovish central banks elsewhere.

There is no hard (or soft) data from the US today, all the new information comes from the speakers, with Powell leading off, and then, Jefferson, Barr and Bostic.  I guess everything will depend on Powell.  Will he try to walk back some of the dovishness that was seen in the press conference or will he double down.  It appears the market expects a less dovish voice.  As such, if he doubles down on the idea rate cuts are coming soon, despite all the data, I would look for the dollar to reverse course.  However, if he tries to but the dove back into its cage, I expect risk assets to be under some pressure and the dollar to hold its gains.

Good luck and good weekend
Adf

Cooed Like Doves

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Well, Jay and the Fed cooed like doves
And treated the bulls with kid gloves
But under the hood
Was it quite so good?
It’s clear number up’s what he loves!
 
The upshot is stocks really soared
As everyone’s sure Jay’s on board
To cut first in June
And thrice when Cold Moon
Is seen, near the birth of our Lord

 

Whatever the pundits thought about the hottish inflation readings in January and February, they clearly did not read the room properly, at least not the room in the Eccles Building.  Despite raising their 2024 forecasts for GDP growth (2.1% from 1.4%) and Core PCE (2.6% from 2.4%), as well as maintaining their forecast for the Unemployment Rate to remain quiescent (4.0% to 4.1%), they are hell-bent on cutting rates this year, with June still the most likely starting point.  I created a little table to show, however, that perhaps the consensus is not quite what the headlines would have you believe.

 DecMar
 MedianAvgMedianAvg
20244.6254.7044.6254.809
20253.6253.6123.8753.783
20262.8752.9473.1253.066
Longer Term2.5002.5862.6252.813

Source: Data FRB, calculations @fx_poet

The highlighted points show that while the median for 2024 remained the same, the average was nearly a full cut less.  In fact, if one more member had adjusted their forecast higher, the median would have come out for just 2 cuts this year.  But as I wrote yesterday, perhaps of more importance is the Longer Term view, where not only did the median rise by 12.5bps, but the average is substantially higher, a full 25bps higher than the December views.  

However, the market has ignored this wonkish number crunching and accepted the numbers at face value; three cuts this year and three more next year helping drive equity prices to yet another set of new all-time highs.

Regarding the tapering of the balance sheet, Powell explained at the press conference that they had, indeed, discussed the topic as they were trying to determine the best way to continue the process without any untoward events, but that is not the issue.  The issue is…BUY STONKS!!!

I would estimate that Chairman Powell is pretty happy with the outcome and am certain that Secretary Yellen is very happy with the outcome.  After all, the equity rally continued while bond yields managed to drift lower by a couple of basis points.  But the really happy campers are the holders of gold which rallied more than 1% and traded above $2200/oz for the first time ever.  The market has reviewed this outcome and decided that the biggest risk going forward is a further devaluation of the dollar vs. stuff, although vs. other fiat currencies it is likely to hold its own.  In other words, inflation ain’t dead.  I expect the bond market to determine this is the case over the next several weeks and see yields rising further, especially if the PCE data next week is hot again.

While Jay may have had the most press
In Switzerland, Tom did aggress
He cut twenty-five
In order to drive
Their growth with a bit more largesse

 

This morning, we have seen three more G10 central banks and the only surprise comes from Switzerland, where soon-to-retire President, Thomas Jordan, cut their base rate by 25bps to 1.50%.  While there were several analysts who had suggested this might be the case (including this poet on Monday), the bulk of the market was in the no change camp.  However, cut they did, and the result was an immediate 1.1% decline in the Swiss franc, arguably a key part of their goal.  In the statement, they explained that inflation had been well within their target range, and they would have the tool of further currency intervention if they felt the franc was weakening too much.

One theory on the surprise cut is that the SNB wanted to get ahead of the pack as they only meet 4 times each year and their next meeting is after the June Fed and ECB meetings.  As well, many pundits are now saying this is the “proof” that the Fed and ECB are going to cut in June.  My take is that while I agree the ECB is a done deal come June, I think the Fed may have a tougher time as there is still no evidence that inflation is heading back to their 2% target.  We have two more CPI and PCE reports before the June meeting, and if the recent price activity continues (and given energy prices remain buoyant I expect they will), it will be very difficult for Chair Powell to explain the need to cut rates unless Unemployment is surging.  Perhaps that will be the case, but right now, the data does not indicate things are collapsing.  The next three months should be quite interesting.

Ok, let’s see how other markets have responded to Powell and the SNB surprise.  Equity markets are in a happy place right now after records fell in the US yesterday.  The Nikkei (+2.0%) also set a new record and the Hang Seng (+1.9%) continued its recent rebound.  In fact, only mainland Chinese stocks couldn’t muster a rally last night, with every other nation in APAC in the green, often by more than 1%.  In Europe, though, the picture is a bit more mixed with more gainers than losers, but still several nations seeing modest pressure on their equity indices.  It should be no surprise that Swiss stock markets are higher, but France and Denmark are suffering somewhat today.  The best performer is the UK (+0.9%) which seems to be benefitting from a solid uptick in its Flash Manufacturing PMI (49.9, exp 47.8).  Lastly, in what should not be a surprise at all, US futures are pointing higher across the board.

In the bond market, all is right with the world this morning as there are bids everywhere with yields declining correspondingly.  Treasury yields slipped another 4bps overnight and throughout Europe, we are seeing declines between 3bps and 5bps with Swiss bonds lower by 7bps.  In fact, Asia is where things were modestly different as JGB’s remain unchanged (tighter policy remains an idea not a reality yet) and Australian yields rose after much stronger than expected employment data was released last night.

In the commodity space, oil (-0.25%) is a touch softer after a decline of more than 1% during yesterday’s session.  With all the focus on the Fed, there was not a lot of news driving things here specifically.  But the real winner in the commodity space is gold (+1.0%) as the market appears to be calling BS on the Fed’s inflation and QT forecasts.  The thing to remember about gold is it is not so much a good hedge for consumer inflation, but it is a very good hedge for monetary inflation (i.e. the excess printing of money).  While those two inflations tend to be correlated, they are not tick for tick, so gold seems to be amiss at times.  But the very idea that despite ongoing inflationary pressures, and the continued supplying of liquidity by the global central banking cast, is the right time to cut interest rates is a step too far for gold markets.  I believe this has room to run higher.  As well, copper (+0.7%) is also rebounding, and I expect that we will see most commodities continue to perform well going forward in this environment.

Finally, the dollar is under some pressure this morning, adding to yesterday’s declines in the wake of the Fed meeting.  Recall, the dollar had rallied the first half of the week as the punditry was looking for the Fed to seem more hawkish.  But that was not to be and this morning it is broadly, though not universally lower.  AUD (+0.3%) and JPY (+0.2%) are the biggest gainers in the G10 while CHF (-0.65%) is the laggard after the rate cut, although has rebounded from its worst levels.  In the EMG space, PHP (+0.4%), MYR (+0.5%) and IDR (+0.4%) are the leading gainers although we are seeing weakness in EEMEA with ZAR (-0.3%) and CZK (-0.3%) lagging.  

On the data front, as it is Thursday, we see Initial (exp 215K) and Continuing (1815K) Claims as well as the Current Account deficit (-$209B) and Philly Fed (-2.3) all at 8:30.  Then as the morning progresses, we see the Flash PMI data (51.7 Manufacturing, 52.0 Services), Existing Home Sales (3.94M) and Leading Indicators (-0.2%).  As well, we get our first Fed speaker post the meeting, vice-chairman for regulation Michael Barr, this afternoon, but given my assessment that the Fed is happy with the market response, I don’t imagine he will say anything new.

Overall, the bulls and doves are walking hand in hand (what a terrible metaphor, sorry) and that means that risk assets are likely to continue to perform well for now and the dollar seems likely to come under a bit more pressure.  I maintain that the bond market is going to figure out the inflation story is not great and react, but that is not today’s story.

Good luck

Adf

Still Inchoate

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The Fed is the talk of the town
Are dots set to move up, or down?
At this point it seems
Those with dovish dreams
Will finish the day with a frown

The other discussion of note
Is balance sheet size and its bloat
Will QT soon end?
Or will it extend?
It seems this idea’s still inchoate

Yesterday I offered my view that the most important potential changes in today’s FOMC statement and releases was the Longer Run median interest rate estimate.  Any change there will imply that the framework in which the Fed has been working is changing.  And one thing we know about changes in frameworks is they bring volatility.  But there is another issue I did not discuss yesterday, QT.  Currently, the Fed is allowing up to $60 billion/month of Treasury securities to mature from their balance sheet without being replaced and up to $35 billion in mortgage-backed securities.  This process has seen their balance sheet decline in size from a shade under $9 trillion in March 2022 to a shade over $7.5 trillion as of last week.

Doing the math, if the balance sheet had declined in size each month by their capped amounts, the current size would have been ~$6.7 trillion, so they have not kept up their desired pace.  The reason is that their mortgage portfolio is not rolling off very quickly since mortgages are not being prepaid at anywhere near the previous rates.  This is due to the impact of the Fed’s actions on the housing market.  Mortgage-backed securities get prepaid when the mortgages underlying are paid off.  That happens in one of two situations, either the house is sold or the homeowner refinances.  With so many homeowners having refinanced when rates were much lower, they have no incentive to do so now, so that channel has been essentially closed.  At the same time, given the dramatic slowdown in the sales of existing homes, that channel is moving at a much slower pace as well.

Prior to the quiet period, Governor Chris Waller gave a speech where he discussed the idea that he would like to see all the mortgages off the Fed’s balance sheet, and the balance sheet hold a far larger percentage of T-bills rather than the current construction of mostly longer-dated coupons.  If this is the consensus view at the FOMC, that means they have a lot of work left to do.  As well, many have questioned whether they can continue to shrink the balance sheet at the same time they are cutting interest rates.  When any FOMC member has been asked that question, they maintain the two issues are separate.  However, I would contend if they do operate in that manner, the results may not be what they want.  It would be a classic pressing on the accelerator and the brake at the same time type of situation.  Another framework change and the chance for more volatility.

It is not clear if the Fed will even discuss the end of QT in their statement although I suspect Powell will have to address the question in the press conference regardless.  But as I look at today’s potential outcomes, the thing that jumps out at me is the chance for several of their decisions to lead to more volatile markets going forward.  And that is across asset classes, so stocks, bonds and the dollar.  It is for times like these that hedging policies are important.  Properly constructed hedges can be very effective at reducing market driven volatility of results, whether corporate or trading profits.

Ok, let’s turn to the overnight session to see how things are shaping up heading into the meeting today.  Equity markets in Asia were generally positive with the Nikkei (+0.65%) recapturing the 40K level.  Chinese markets were ever so slightly firmer despite the fact that the PBOC left the Loan Prime Rate unchanged.  There seemed to be a lot more hope for a change than evidence the PBOC would act.  Europe, on the other hand is having a little more trouble this morning with most markets softer led by the CAC (-0.6%). The outlier here is the DAX (+0.2%) which seems to be responding to a larger than expected decline in German PPI to -4.1% Y/Y.  The implication is German corporate margins may improve.  As to the US, at this hour (7:15), futures are edging higher by about 0.1% across the board after another solid session yesterday.

In the bond market, Treasury yields have edged down 1bp in the 10yr with similar movement across the curve.  In Europe, yields have fallen a bit more, between 3bps and 5bps with UK Gilts (-5bps) leading the way after CPI data this morning printed at a softer than expected 3.4% headline, 4.5% core.  With the BOE on tap tomorrow, investors believe this improves the odds of a more dovish outcome, although no rate cuts are likely at all.

As to the continent, Madame Lagarde regaled us this morning with the following: “Our decisions will have to remain data dependent and meeting-by-meeting, responding to new information as it comes in. This implies that, even after the first rate cut, we cannot pre-commit to a particular rate path.”  In other words, she continues to sing from the same hymnal that all the G10 central bankers are using.  Once again, I don’t understand why anyone would believe that the central banks will be able to pivot on a timely basis if/when recession is coming.  By maintaining their data dependence, they are assured that they will be reactive, not proactive, since all data is backward looking.  And one more thing, JGB yields have been unchanged since the BOJ policy change.  Tighter policy is not in the cards here either.

In the commodity market, everything is under a bit of pressure this morning with oil (-0.8%) slipping back a bit on what seems more like a trading response than a fundamental change in anything.  EIA data later today can certainly have an impact if the recent drawdown in inventories continues because production does not appear to be increasing anywhere.  In the metals markets, gold is a hair softer, although remains within spitting distance of its recently traded all-time highs while copper (-1.0%) has been slipping the past several sessions and is basically right back at $4.00/lb.  This market remains beholden to the growth story overall, and China’s lack of activity last night is probably weighing on the red metal here.

Finally, the dollar is still kicking butt and taking names with the DXY back above 104 this morning.  The yen has not found its footing yet, trading to 151.65, down another -0.5%, and really getting hammered on the crosses vs. the euro and the pound, at all-time lows there.  But really, this remains a dollar strength story as hopes continue to recede for the Fed to start easing policy very soon.  On a relative basis, the US economy continues to be the best performing major economy (7% budget deficits will do that for you), but the reality is reasons for the Fed to start cutting rates remain scarce.  Until those change, the dollar should continue to perform well.  And remember, when that does change, we are likely to see every G10 nation cutting rates aggressively, so the dollar should still hold up well.

And that is it.  There is no data ahead of the Fed so I imagine we will all collectively hold our breath until the statement at 2:00 and Powell’s presser at 2:30. Until then, I foresee little in the way of movement.  After that, it all depends on what he does and says.

Good luck
Adf

He’s Got Spine

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The market’s now certain that June
Is when Jay, the funds rate, will prune
Inflation don’t matter
Despite all the chatter
They don’t want to cut rates too soon
 
But what if inflation keeps rising?
And data continues surprising?
Can he hold the line?
And show he’s got spine
Despite all the doves’ vocalizing?

 

It’s funny.  So much was made about the CPI number on Tuesday and the lines seemed to have been drawn quite clearly; soft or as expected data would cement a June cut while hot data would call that into question.  And yet, here we are two days later, with the only information in the interim showing that oil and product inventories have fallen further driving oil prices higher, and the probability of a June cut has risen above 90%.  In fact, amid a day with limited new information, and during the Fed’s quiet period, perhaps the most interesting comments came from Treasury Secretary Yellen.  Not only did she indicate she regretted her use of the word ‘transitory’ at the beginning of the inflation episode, but more importantly, it appears that Treasury is now assuming much higher interest rates in their forecasts than before.  In other words, she no longer believes that interest rates are going to head back down to 2%.  Personally, I think that is a huge step in the right direction.  Alas, that concept certainly did nothing to constrain their spending plans, so it is not clear it really matters.

But the reality as that even though we get some more Tier 1 data this morning, it has become quite clear, to me at least, that the market is uninterested in anything other than the FOMC statement, the dot plots and Powell’s press conference coming on Wednesday next week.  You can see this in the equity markets which are now trading in ranges after their recent sharp rises, and you can see this in the FX market given the dollar’s virtual complete lack of volatility.  In fact, the only place that is demonstrating some concern is the bond market, where yields continue to edge higher very slowly.

Let’s start by taking a quick look at this morning’s data.  Retail Sales (exp 0.8%, 0.5% ex-autos) is set to rebound from last month’s terrible -0.8% print.  Many have looked past that number as a combination of bad seasonal adjustments and heavy discounting and continue to see strength in the economy.  We also see PPI (0.3%, 1.1% Y/Y) and Core (0.2%, 1.9% Y/Y) which seems to have bottomed, not dissimilar to CPI, but which will be a problem for those who believe that inflation is still trending lower.  Finally, as it is Thursday, we see Initial (218K) and Continuing (1900K) Claims, both in line with recent outcomes signaling the labor market remains in solid shape.

Now, you all know my view that inflation is not dead and that the market will need to continue to adjust interest rates higher over time to account for that fact.  Since the beginning of the year, as you can see from the chart below courtesy of tradingeconomics.com, while there have been several cycles, it seems clear that the trend in yields remains higher.

I think this makes a lot of sense and expect it to continue.  In fact, the question I have is how can the Fed truly consider it will be appropriate to cut the Fed funds rate given the economic signals are showing continued solid growth, a solid labor market and indications that inflation is heading higher?  Many make the political argument that since they are hell-bent on cutting, they need to get started before it gets too close to the election.  But I am going to go out on a limb here and say that I think Powell has shown he is made of sterner stuff and if the data remains where it has been, let alone inflation ticks higher between now and June, there will be no rate cuts.  If I am correct, risk assets are going to rerate, trust me.  And that is really the only question that needs to be answered at this point.

And so, other than bonds which seem to be sussing out the potential for rates to continue at their higher-for-longer pace, a look at other asset class markets shows not much overall movement.  After yesterday’s mixed US session, Asia, too, was mixed with Japan slightly firmer while Chinese shares slid as there appears to be no real help in sight there.  European bourses are also mixed with the UK lagging and slightly softer on the day and the bulk of the movement higher quite modest.  The only exception is the CAC in Paris higher by 0.9%, on the back of continued strong performance of the luxury goods sector.  (As an aside, why would central bankers think that the economy is going to tank if luxury goods remain hot?). US futures, though, are firmer at this hour (7:30) with all three indices higher by 0.5%.

In the bond market, while US yields have been dragging the global structure higher, they are unchanged on the morning and European sovereigns are actually a touch softer, between 1bp and 2bps today.  That is likely on the back of comments by Greek ECB member Stournaras that they need to quickly make two rate cuts to manage things properly.  While that seems excessive, I maintain the ECB cuts before the Fed.  As to Japan, JGB yields have edged higher by one more basis point overnight, though remain at just 0.77%.  Ueda-san, when he speaks, sounds far less hawkish than many of the analysts in Tokyo, or the other members of the BOJ from whom we have recently heard.  I am still in the April camp for the first rate hike, and very few afterwards.

Oil is the big mover of the day, up 0.9% with WTI back over $80/bbl for the first time since early November.  Yesterday’s EIA Inventory data showed drawdowns in crude and gasoline stocks that were much greater than expected.  You may have noticed at the pump that gas prices are rising, and it seems the market is figuring that out as well.  Remember, though, that OPEC+ has reduced production so has significant spare capacity at this stage, probably 2mm – 3mm bbl/day that they can restart at any time, so I don’t expect prices here to skyrocket.  Gold, which rallied nicely yesterday, is slightly softer this morning, as is copper, although the red metal remains above $4.00/Lb.  It strikes me that the commodity markets are not anticipating a significant economic slowdown right now.

Lastly, the dollar is very little changed overall this morning, with the largest moves NZD (+0.25%) and PLN (-0.25%) and every other major currency seeing less movement than that.  USDJPY is pushing back toward 148.00 slowly and seems likely to be the next big mover based on Monday night’s BOJ meeting.  Otherwise, this space is dead.

And that’s really what we have for the day.  If the data is hot, look for yields to continue their recent climb and for the dollar to take on a bid tone.  As to stocks, demand remains strong regardless of the economics.  If the data is soft, then a weak dollar should accompany strength in both stocks and bond prices.

Good luck

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Not Very Far

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Said Jay, we are not very far
From when we can all wave au revoir
To higher for longer
With confidence, stronger,
Inflation will reach our lodestar
 
“We’re waiting to become more confident that inflation is moving sustainably at 2%.  When we do get that confidence — and we’re not far from it — it’ll be appropriate to begin to dial back the level of restriction.”  So said Chairman Powell yesterday in front of the Senate Banking Committee in response to some of the questions he received.  Nuff said!  Regardless of the fact that there has been limited indication of slowing economic activity (although this morning’s payroll report will be critical), it seems quite clear that Powell is under a great deal of pressure to reduce rates.  One must assume this pressure comes from the White House as in last night’s SOTU speech, President Biden even mentioned that mortgage rates were too high, and he was going to push them down.  Clearly, the only tool that Biden has is to lean on Powell to cut rates.
 
But despite what had appeared to be a concerted effort by every Fed speaker to push back against the proximity of the first interest rate cut for this cycle, it appears that Powell is blinking.  Interestingly, while the Fed funds futures markets didn’t really adjust very much, we did see the 2yr Treasury yield fall back 5bps and this morning it sits slightly below 4.50%, its first time back to this level since the surprising CPI print last month.  Of course, equity markets love the message, and we continue to see new highs on a daily basis.  But we are also continuing to see new highs in the anti-fiat monies, gold and bitcoin.  The world is not without risk.
 
An angry old fella named Joe
Last night tried explaining our woe
Was not his, to blame
Though he wouldn’t name
The culprit, throughout the whole show
 
While I try to leave politics out of this missive, the status of the SOTU is such that I don’t believe it can be completely ignored.  My takeaway from last night’s speech was that President Biden, in an attempt to show vigor, came across as the angry old man shaking his fist and yelling at the clouds.  He had a laundry list of things he claims to want to accomplish, all of which will cost trillions of dollars, and none of which are likely to be enacted before the election.  Many pundits pointed out this seemed more like a campaign speech than a SOTU and I think there is merit in that view.  In the end, while we understand where the pressure on Powell is coming from, I don’t believe this is going to change anything, certainly not from a market perspective.
 
And finally, it’s time to turn
To data for which we all yearn
The Payroll report
Which, if it falls short
Will likely give hawks great heartburn

Looking ahead, this morning brings the monthly payroll report.  Current median expectations are as follows:

Nonfarm Payrolls200K
Private Payrolls160K
Manufacturing Payrolls10K
Unemployment Rate3.7%
Average Hourly Earnings0.3% (4.4% Y/Y)
Average Weekly Hours34.3
Participation Rate62.6%

Source: tradingeconomics.com

Recall, last month’s number was massively higher than anticipated at 353K and had higher revisions as well.  The revisions were almost more surprising than the headline number as the trend for the entire previous year had been for revisions to be to softer data.  There will certainly be revisions to the January data as well, so there is a great deal of uncertainty.  My sense is, though, that the market really wants to see a softer number with downward revisions as that will work toward cementing the case for the Fed to cut rates even sooner.  Sub 150K and look for a bond and stock rally.  Above 250K and bonds will sell off, although stocks have a life of their own.  At least that’s one man’s view.

Ok, let’s look at how things played out overnight ahead of this key data.  Asian markets followed the US rally with green across the screen.  The Hang Seng, which is seen as the tech proxy in Asia, rallied most, 0.75%. Europe, on the other hand, is having a tougher day with most markets slightly softer although the FTSE 100 is down -0.5%, the clear laggard this morning.   Apparently, Madame Lagarde’s comments did nothing to support the hopes that rate cuts were coming soon as ostensibly, rate cuts were not even discussed in the meeting and all signs point to June as the first time by which they will have confidence in the inflation story, if it is to come.  Meanwhile, US futures are pointing a bit lower, -0.3%, at this hour (8:00).

In the bond markets, Treasuries have edged lower another 1bp this morning and we are seeing yields across the board in Europe decline by between 2bps and 4bps.  I can’t tell if that is confidence in the ECB (doubtful) or belief that the ongoing decline in economic activity (Eurozone GDP in Q4 was confirmed at 0.0% Q/Q and 0.1% Y/Y) has simply encouraged investors that rates are going to fall with no chance of a backup.  Meanwhile, JGB yields were unchanged overnight despite the ongoing excitement(?) that the BOJ may raise rates a week from Monday.

Oil prices have retreated a bit (-0.6%) but are essentially range trading and have been for the past month.  However, the star of the commodity space continues to be the barbarous relic, with gold rallying another 0.3% this morning to yet another new all-time high.  As to the base metals, copper is unchanged this morning, but has been on a roll lately while aluminum is higher by 0.65%.  Metals investors are gaining confidence that not only is there going to be no landing in the US, but that China is going to stimulate more.

Finally, the dollar remains under pressure overall as yields continue to decline.  While the euro is a touch softer this morning, virtually every other G10 currency is firmer with JPY (+0.55%) leading the way.  Remember, too, that with FY end approaching for Japan, we will begin to see Japanese corporates repatriating funds which typically sees further yen strength.  Combine that seasonal activity with the relatively new BOJ hawkishness/Fed dovishness combination and the yen could rally a lot more.  After all, it has fallen a lot in the past two years!  But, while the G10 currencies are generally having a good day, the picture in the EMG bloc is far more mixed with BRL (-0.6%) the laggard after total credit in Brazil was shown to have fallen in January for the first time since the pandemic.  On the flipside, CLP (+1.0%) is rallying after a higher-than-expected CPI report (4.5%) has traders looking for tighter monetary policy than previously anticipated.

Aside from the payroll report, there is no other data to be released and there are no Fed speakers on the calendar.  Yesterday we did hear Cleveland Fed president Mester sound more hawkish, becoming the third FOMC member to discuss only 2 cuts this year, and I maintain that when the dot plot comes out, that could be the median view.  But for now, markets and investors remain euphoric about the apparent Powell dovishness, so that will be the driver absent a huge NFP this morning.  For the dollar, that will be bad news.

Good luck and good weekend

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No Confidence

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So far, we’ve no confidence that
Inflation is down on the mat
Thus, rates won’t be sinking
Til prices are shrinking
Said Jay in his Wednesday House chat

But also, it seemed clear to all
No rate hikes were likely on call
With that set aside
He then did confide
That Basel III cap rules may fall

It can be no surprise that Chairman Powell’s testimony yesterday explained that the Fed is still not yet confident that inflation is going to achieve their 2% target on a sustainable basis.  While he was clear that most of them thought that would eventually be the case, the proof is not nearly conclusive at this stage.  Of course, this is exactly what he told us last month and essentially what every Fed speaker since has repeated.  He did appear to rule out any further rate hikes at this time, but quite frankly, if inflation readings start to head higher, you cannot take those off the table.  At the very least, the current Fed funds futures pricing for cuts (3% in March, 20% for May and 87% for June show the market has really decided the first cut is a summer event.  Remember, though, between now and the June 12 meeting, we will see three more CPI and PCE reports as well as three more NFP reports.  It would not be impossible for these ideas to change between now and then.

One other thing to note is we have heard several FOMC members now discuss needing only two rate cuts this year.  Do not be surprised if the March dot plot has that as the median forecast and that would be a significant change to market perceptions.

The essence of the questions by the Congressmen and women revolved around two things; the fact that high rates were hurting people trying to buy houses and how proposed capital increases due to the Basel III regulations were going to kill the banking community.  While Powell empathized with the housing issue, he reminded them all that inflation hurts everyone.  But the big surprise was Jay indicated that he may overrule Regulation vice-chair Barr and look to reduce some of those capital requirements.  Not surprisingly, the GSIB bank stocks rallied on the news!

And in fact, so did the overall stock market.  The combination of what seemed to be a promise to avoid further rate hikes and relaxing capital requirements was just what the doctor ordered to alleviate Tuesday’s pain.

Is the table set
For a March policy change?
A new wind’s blowing

The yen (+1.1%) is on the move this morning after a combination of news that Rengo, the Japanese Trade Union Confederation, is asking for wage increases of 5.8% this year, the highest request in 30 years.  While they will likely not get the full amount, certainly wages are set to rise more substantially than in a long time there.  This is music to PM Kishida-san’s ears as he wants to see more spending, and apparently, this is AOK with Ueda-san who now believes that their 2% price target has a greater chance of being sustainable.  Alongside the yen’s rally, the OIS market has bumped up the probability of a March rate hike to above 50% and several analysts in Tokyo are making that their new call.

Thinking about the situation here, the BOJ meets a week from Monday, 2 days prior to the FOMC.  It strikes me that we have the opportunity for some real volatility as if Ueda-san does raise their base rate to 0.00%, I expect the market will be looking at this being the beginning of a series of hikes and start to move the entire Japanese interest rate curve higher.  That will be bullish for the yen.  But…if the Fed’s dot plot comes in at only 2 cuts, or possibly even 1 cut this year, that is also quite hawkish for the US rate situation, will likely see the yield curve back up and should support the dollar.  The reason we hedge is to prevent movement of this nature from having too great an impact on results.  Keep that in mind.

Interestingly, I believe those two stories are far more important to markets than the ECB meeting this morning.  There is virtually no chance of any policy change, so the real question is how the statement addresses the situation for the first rate cut and its potential timing.  The commentary that we have heard to date, at least to my ears, has been a split between April and June, with a slight nod toward the latter.  One key clue will be the updated economic and inflation forecasts with some analysts looking for lower outcomes there.  If that is the case, I expect that April will get a lot more press.

But ahead of the meeting, I would argue that the narrative is shifting as follows:  the Fed has indicated that the peak has been reached and it’s simply a matter of time before they start to cut rates while the ECB has been trying to hold out their hawkish bona fides.  As such, it should be no surprise that the dollar is under some pressure and the euro has rebounded to 1.09 for the first time since mid-January.  However, there is still a lot of new information on the horizon, specifically tomorrow’s NFP and next week’s CPI which can quickly alter the Fed narrative and with it, the dollar narrative.  Be careful.

Ok, let’s look at the overnight session where, not surprisingly, the Nikkei (-1.2%) fell on the back of the hawkish sentiment and stronger yen.  It has fallen back below the 40K level, so it remains to be seen if this is temporary or if, after 40 years, the new top was just barely above the old one.  Chinese shares were also weak despite a very strong Trade Balance, although the rest of Asia followed the US higher.  In Europe this morning, Spain’s IBEX (+0.6%) is once again leading the way higher although the major markets, FTSE 100, DAX and CAC are all little changed on the day.  Finally, at this hour (7:15), US futures are edging higher by about 0.25%.

In the bond market, yesterday saw Treasury yields fall 4bps and they are down a further 1bp this morning.  Market participants are going all-in on the idea that Fed funds are going to get cut soon.  I am not comfortable with that viewpoint at all.  As to European sovereigns, they too, have seen yields slide a bit, down 2bps-3bps this morning.  All this is in contrast to JGB yields, which backed up 2bps overnight on the new hawkish take.

In the commodity markets, oil (-0.75%) is softer this morning, unwinding yesterday’s modest rally.  For now, there has been much less focus on energy than on the interest rate story although I suspect that will change again going forward.  Gold (+0.4%) continues to be the absolute star of the commodity space, rallying for the 7th consecutive session and extending its all-time high levels.  My take is there is much more room on the upside here as it is not a widely held trade and if it continues, the momentum guys are going to want to get in.  But we are also seeing strength in the base metals with both copper (+1.3%) and aluminum (+0.9%) having strong sessions.  As long as the narrative is looking for US rate cuts, these metals have further to climb.

Finally, the dollar is under pressure everywhere, not just in Japan.  Both Aussie (+0.65%) and Kiwi (+0.5%) are strong on the back of commodity strength, and we are even seeing NOK (+0.2%) rise despite oil’s decline.  If you needed proof this is a broad dollar selling environment, that’s it.  Interestingly, in the EMG bloc, while almost every currency is firmer, the movement has been quite small, with nothing more than +0.2%.  So, this seems to be a comment on the ostensibly dovish Powell testimony that has bolstered the US stock market.

On the data front today, after the ECB leaves rates on hold at 4.5% we see Initial (exp 215K) and Continuing (1889K) Claims leading the way as they do every Thursday.  We also see the Trade Balance (-$63.5B), Nonfarm Productivity (3.1%) and Unit Labor Costs (0.6%) at 8:30.  Powell starts up again in front of the Senate at 10:00 and then this afternoon, Consumer Credit ($9.25B) is released.  In addition to Powell, we hear from Loretta Mester of the Cleveland Fed.  It will be quite interesting if she hints at only two cuts this year, following Goolsbee and Barkin.  I have a feeling that is the current direction and that is not in the pricing right now.

For now, the dollar remains under pressure, so unless Powell is perceived to be more hawkish this morning, I suspect the dollar can slide a bit more before it’s all over.

Good luck
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The Really Good Stuff

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While yesterday’s markets were tough
Today starts the really good stuff
It’s ADP first
Then Jay’s well-rehearsed
Defense the Fed’s doing enough

 

As I suggested in yesterday’s note, markets had a little further to fall prior to the beginning of the information onslaught that is coming today and continues for the rest of the week.  Apparently, this was the worst session since sometime in October, but in the broad scheme of things, a 1.0% – 1.5% decline doesn’t seem that dramatic.  After all, even after yesterday’s declines, the NASDAQ 100 is higher by 8.1%, the S&P 500 by 7.1% and the Dow Jones by 2.3% so far this year.

This morning, however, I think we need to look ahead to what is on the near horizon as I believe today’s information may be the most important of the week.  Before we get into the US story, a quick note on Europe and the UK.  Many of you will recall that during the Brexit drama in 2016, the Remainers claimed that the UK economy would collapse if they left the EU.  I cannot help but notice how it is the continent which is suffering the worst effects of the current economic situation with the UK faring quite a bit better.  

One need only look at the PMI data as evidence that while things in the UK may not be great, the Eurozone is in much worse condition.  Today’s Construction PMIs are a perfect encapsulation with the UK printing 49.7, not great, but miles ahead of Germany (39.1), France (41.9), and the Eurozone as a whole (42.9).  And this has been the pattern of data we have seen consistently for the past several years.  While the UK may have suffered somewhat, Europe is in far worse shape.  Looking at the data, it is easy to see why expectations for the ECB to cut rates first are rising.  They need to do something to support the Eurozone economy.

But anyway, let’s turn to this morning’s activity which starts with the ADP Employment number (exp 150K).  The relationship between this and the NFP data seems to have broken down a bit lately, but it remains a key early look at the US employment situation.  While 150K does not indicate remarkable strength, it would be the second highest print in the past six months, a time when the economy has grown at a > 3.0% clip.  I feel like the market will pay attention to a big miss in either direction, especially a weak number as that will be seen as a harbinger of rate cuts coming sooner.

The next thing we get is the Bank of Canada rate decision, where the universal expectation is for no adjustment in the current 5.0% rate.  Here, the issue will be much more about the tone of the statement and commentary.  Recent inflation data in Canada has been softer than expected, slipping below 3.0%, but growth data continues to motor along well.  There are many in the markets who believe that the BOC will lead the way in policy changes, and if they indicate a cut is coming soon, the Fed will follow.  Personally, I don’t buy that, but then, I remain unconvinced the Fed is going to cut at all.

Which takes us to Chairman Powell’s Senate testimony starting at 10:00am.  If I were to guess on the nature of his opening statement it will be something along the lines of; things are going well as growth is solid, unemployment remains low and inflation seems to be trending lower, however, inflation remains job #1 and we are not yet convinced it will sustainably reach our goal of 2%.  He will then get a series of bizarre and idiotic questions from Senators who have virtually no understanding of the economy, and only care about grandstanding on TV for their constituents.

But this is where the most opportunity for a market moving event will take place.  If Powell offers anything other than the above recap, look for markets to react quickly.  Any hint that they are closer to a cut, and we will see equities fly and the Fed funds futures markets rally sharply (remember the December pivot?).  Any hint that cuts seem unnecessary given the overall economic strength and continued low unemployment rate and look out below.

And that’s how the day is shaping up.  However, it would not be complete if I didn’t mention perhaps the most important inflation indicator I have seen to date, and perhaps a harbinger of the future.  Of course, I am referring to the Average Tooth Fairy payout as seen below.

I found this on the Morning Hark, a terrific Substack that does a great job of aggregating information published all around the world every day, and one I cannot recommend highly enough.  But let’s face it, if the tooth fairy is cutting back her (his? Its?) payout, inflation must be dead!

Ok, it’s time to review the overnight activity.  Following yesterday’s declines in the US, Asia had a mixes session with the big winner being the Hang Seng (+1.7%) on the strength of a strong earnings report from JD.com as well as a rebound from the prior session’s sharp declines.  But elsewhere, things were mixed with limited movement overall.  In Europe, the screen is green, but only Spain’s IBEX (+1.15%) is showing any real life, with the other bourses just barely above flat.  You will be happy to know, though, that US futures are all pointing higher at this hour (7:30) by between 0.25% and 0.75%.

In the bond market, things are stable although yields have drifted a bit lower over the past several sessions.  This morning, Treasury yields are down just 1bp while we are seeing a mixed view in Europe with different nations seeing moves of + or – 1 bp.  But in general, not much to note here.  As to Asia, yields fell overnight, following the US lead of late, with JGB’s the lone exception, creeping higher 1bp.  Arguably, the fact that the bulk of the movement has been 1 basis point tells us nothing is going on!

In the commodity market, oil is rebounding slightly this morning, up 0.9%, which reverses earlier losses this week.  The star here continues to be gold (+0.3%) which has risen 5% to new all-time highs this week and looks like it is not going to stop in the near future.  Alongside the sharp rally in Bitcoin, a case can be made that investors are seeking out non-monetary alternatives given the massive debt issuance that is ongoing in the US, as well as elsewhere in the world.  For instance, yesterday China mentioned they were going to be issuing an additional CNY 1 trillion of ultra-long-term bonds to finance some stimulus.  It is not unreasonable for investors to seek non-monetary stores of value when concerns arise over non-stop issuance of paper.

Finally, this morning the dollar is a bit softer against virtually all its counterparts.  While the movement has not been large, the breadth of the decline could be indicative of a view that Chairman Powell is going to be cooing like a dove today.  This is especially so if one has a political view as after yesterday’s Super Tuesday primary results, the presidential race has been cemented as a rematch of 2020.  Many make the case that Powell does not like Trump, especially given Trump has said he will not reappoint Powell.  But I don’t think that Powell cares about that as much as about trying to get things right.  He is independently wealthy and can retire with his head held high if he can get inflation back to target.  

We’ve already discussed the data although I left out the JOLTS Job Openings (exp 8.9M) at 10:00, and then the Beige Book is released at 2:00.  We also hear from Minneapolis Fed president Kashkari, but will anybody really care what he says having just heard from Powell himself?  I think not.

So, today is all about early data and more importantly Powell’s comments.  I continue to believe that the Fed does not need to cut rates at all given the economic backdrop and despite the Tooth Fairy, inflation will remain sticky and above the Fed’s target.  As the market prices out Fed rate cuts, the dollar should benefit, but that will take more time.

Good luck

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Jejune

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Come Wednesday through Friday this week
It’s payrolls and Powell to speak
Let’s take time today
To hear people say
What’s driving the year-to-date streak
 
The first key is so many think
That Powell and friends need to blink
And cut rates quite soon
Else markets will swoon
And ‘flation will not rise, but sink
 
The other idea that’s around
Is AI and Bitcoin are bound
To fly to the moon
An idea, jejune,
For OG’s, though elsewhere profound

 

Once again, lackluster was an apt description of the market activity yesterday, although given the plethora of information that is on the horizon, we cannot be surprised by this result.  As such, I thought it might be worthwhile to review the themes that seem to be driving markets these days, as well as how expectations are built into pricing.

Clearly, the biggest story remains the Fed and its potential timeline for the mooted rate cuts necessary to achieve the much-vaunted soft landing.  As of this morning, the probability of a May cut remains near 24% with June the odds-on favorite for the first action.  While there has been some back and forth with respect to the actual probabilities, there has been no major change in that view for several weeks.  My question continues to be, why are so many people of the opinion that the Fed must cut rates?  

So far, at least based on both the GDP and payroll data, the economy is chugging along quite well with the current monetary policy settings while inflation remains well above the Fed’s target.  Arguably, a great deal of that is due to the fiscal impulse that has been ongoing, but there is no sign that is going to end anytime soon.  In fact, it strikes me that easing monetary policy amid a period of fiscal excess may juice the inflation data substantially.  Literally every Fed speaker has made this exact point, that things are going well, inflation seems to be trending lower, but there is more certainty needed before a cut would be appropriate.

Adjacent stories here are related to the election in the US, with many assuming the Fed will cut rates to help support the Biden administration (I think this is extremely unlikely).  The other key story has to do with the other G7 central banks, and their ability/willingness to change policy prior to the Fed.  Considering that Japan, Canada, the UK and Europe are all basically in recession, or right on the cusp, there is a far greater need to ease monetary policy in those places.  However, they have a serious concern that if they cut before the Fed, the dollar will rally sharply and negatively impact both economic activity and market activity, as well as undermine their currencies.  In the end, everybody is waiting for Godot Powell, and it is not clear he is going to come through.

The second key story is the remarkable performance of both Bitcoin and the tech sector.  There have been many stories comparing the current move in the NASDAQ to various times in the late 1990’s and the runup to the Tech bubble then.  We all know that eventually, despite the internet having an amazingly profound impact on all our lives, the tech sector corrected more than 80% from its early 2000 peak and it took 15 years to regain those levels.  I don’t think anybody is willing to say that the current tech leaders are bad companies with problems, but the price one pays for a company’s shares is THE key to long-term investment performance.  AI can be transformative in many ways and that doesn’t mean these shares will not decline and decline sharply.

Speaking of AI’s impact, my good friend the @inflation_guy, Mike Ashton, wrote a terrific piece about the potential impact on the economy overall, comparing it to the internet, the last significantly transformative technological revolution.  This is a must read!  Ultimately, while the impact of the internet was significant, it was not nearly as productivity enhancing as many had forecast at the initial stages of the mania.  Just keep that in mind with respect to AI as well.

As to Bitcoin, it is pushing to new all-time highs as flows into the spot ETF’s are quite substantial and driving the move.  However, it strikes me that the rationale for buying Bitcoin is very different than the rationale for buying NVIDIA.  Bitcoin believers are concerned over the integrity of the entire concept of money and its future.  They look at the dramatic increase in Treasury issuance and ask, is that debt really risk-free?  They are seeking to own alternative assets, outside the current monetary framework.  Meanwhile, buying the AI craze is as mainstream as you can get, counting on the equity values to rise substantially from here and protect your wealth, even if it is denominated in a currency that is subject to inflation and devaluation.  But for now, the two are linked at the proverbial hip.  

I would not look to short either process at this point, but having seen numerous bull markets in my time, the one thing I know is that trees don’t grow to the sky.  At some point, there will be a significant correction in both these asset classes, and we are sure to hear a great deal of screaming about how the Fed needs to come in and stop it.

In China, last night Premier Li
Revealed what their growth ought to be
Though clearly well-meant
To reach five percent
Is certainly no guarantee

 

One other key story overnight was Premier Li Qiang’s speech in which he declared the GDP growth target for China this year is “around 5%” with inflation to run at 3% and a budget deficit also at 3%.  While this all sounds great, there is reason for some skepticism.  Perhaps the biggest issue is that domestic demand for products is not growing and is unlikely to start doing so until the property crisis is behind them.  However, given President Xi’s unwillingness to face that music, the drawn-out process to address the situation will likely weigh on overall economic activity for a few more years yet.  

There is a potential knock-on effect of this, though, and something that I have not really considered in the past but need to investigate further.  We all know that there is a concerted effort by G10 nations to reshore and friendshore manufacturing capacity, and that has been a key driver of US economic activity.  Recall, that was the entire goal of the Inflation Reduction Act.  It has also been clear that there is currently a boom in factory construction in the US, something else supporting GDP data.  Now, if the US, and much of the G10, is adding to manufacturing capacity while China maintains its own manufacturing capacity, that is a LOT of capacity to build stuff.  It is not unreasonable to expect that the prices of manufactured goods will decline given what could well be significant excess supply.

In the US, regardless of who wins the presidential election, it is very easy to foresee another increase in import tariffs on Chinese goods (Trump has proposed a 60% tariff on all Chinese imports).  We have heard similar rumblings from Europe as well.  The point is that absent a substantial change in trade policy, goods inflation is likely to be well-contained.  Services inflation is a different issue, and given services represents a much larger proportion of the US economy, seems likely to keep price pressures pushing higher.  But rampant price rises are far less likely if we wind up with duplicate production sources for various goods.  Of course, tariffs will feed directly into inflation data, and the Fed cannot address that at all.

My point is that the economy is a highly interconnected and complex system and tracking all the potential outcomes is extremely difficult, if not impossible.  This is just one that I hadn’t considered in the past but may have some legs.  To be continued…

Ok, I have gone on too long so here’s the recap for overnight.  The Hang Seng sold off (-2.6%) but otherwise in Asia and Europe shares are little changed.  Yields are broadly lower (Treasuries -3bps, Europe -5bps on average) while oil prices have slipped a bit.  Gold (+0.5% and new all-time highs) is the commodity outlier.  Finally, the dollar remains little changed and is likely to stay that way until we see the next monetary policy adjustments.

ISM Services (exp 53.0) is the only data release today and only Michael Barr is speaking. I see no reason for things to move very far until tomorrow, when both ADP Employment is released, and Chairman Powell testifies.  Equity futures are pointing a bit lower this morning after a soft session yesterday.  That drift feels like it can continue as we await the rest of the week’s news.

Good luck

Adf

Not Fear, But Greed

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It seems that on Friday, we learned
The prospect for rate cuts upturned
The ISM sunk
And Michigan stunk
So, doves got the data they yearned
 
And so, things are priced for perfection
Though history cautions reflection
Is what we all need
As not fear, but greed
Is likely to cause the correction

 

Markets are funny things with a history of reacting to catalysts that were completely unexpected while ignoring the ‘big’ things all the time.  Friday was a perfect example as the release of some second-tier data, ISM and Michigan Sentiment, drove a major change in the narrative and market prices in every asset class.  Prior to the Friday data releases, which saw ISM Manufacturing fall to 47.8, far below last month and forecasts, as well as the Michigan Sentiment index fall to 76.9, also well below last month’s number and forecasts, there had been a steady stream of strong data and hawkish Fed rhetoric.  

By now, you are all familiar with the Fed’s general lack of confidence that inflation is going to return to their 2.0% target soon as that sentiment has been expressed by, literally, all 17 FOMC members in the past three weeks.  The result of the hawkish talk and the solid data was a repricing in the Fed funds futures market of just how many rate cuts were coming in 2024, as well as their timing.  As well, we saw Treasury yields back up nearly 50bps during the month of February as the concept of higher for longer was finally getting internalized by market participants.  

But observing the market’s behavior, it was never clear that investors and traders really believed that tale of higher for longer.  Undoubtedly, there has been a camp, FX poets included, who have been singing that tune all year long.  But a much larger camp has been convinced that inflation was clearly on its way to 2% or lower and the Fed would want to cut sooner rather than later.  The rationales for these cuts had very little to do with the economy and focused instead on one of two things; the election this year and their effort to prevent President Trump from being elected support the current administration, or the fact that the extraordinary amount of funding that the Federal government needs to pay for its increasing deficits requires lower interest rates to prevent a fiscal disaster.

Then along comes Friday’s data and much of the Fed’s hard-won respect regarding higher for longer got tossed right out the window.  Treasury yields fell sharply, down 8bps, while the futures curves upped the ante for a May rate cut and made June that much more certain.  Not surprisingly, equity markets got quite the boost, although they have mostly been ignoring the rates story anyway. But perhaps the most interesting thing was what happened in the gold market, where the price of the barbarous relic jumped nearly 2% on the idea that rates were set to decline in the face of still high inflation.

It is important to remember that these two data points were, as I said at the top, secondary.  The fact that both pointed to economic weakness after a long string of strong data points was interesting, but was it really a signal that the trend has changed?  Personally, I am skeptical that is the case.  However, for a market that was looking for a reason to push back on the growing narrative of fewer rate cuts, they were a welcome sight.

In the broad scheme of things, though, this week is likely to be far more important in helping us all understand the nature of the current economy as well as the ongoing Fed reaction function thereto.  After all, not only do we hear from Chairman Powell as he testifies to the Senate and House on Wednesday and Thursday respectively, but Friday brings the payroll report.  Too, on Wednesday the Bank of Canada and on Thursday the ECB meet to lay out their latest views.  Remember, too, that the Chinese National People’s Congress is being held this week, and while leaks are rare, they will ultimately be announcing their growth targets for the year, so another crucial piece of information.  Net, I do not believe that last Friday’s data will have changed the minds of any FOMC members, and continue to believe that even a June cut is a low probability absent a significant overall economic decline, including lower inflation data.  But then, that’s what makes all this so exciting  A yellow face with a black line Description automatically generated.

As we await all the activity to come, let’s recap the overnight session.  In Asia, only the Nikkei (+0.5%) managed to generate any excitement as it made yet another new all-time high and breached the 40,000 level for the first time.  Chinese shares were dull as was most of the rest of the region.  In Europe, the picture is mixed although the only mover of note is the FTSE 100 (-0.6%) which seems to be declining on the prospects of a lackluster budget announcement by the government this week.  Otherwise, bourses here are within +/- 0.2% of Friday’s closing levels.  And at this hour (8:00), US futures are edging slightly lower.

In the bond market, Treasury yields are backing up from Friday’s decline, rising 3bps this morning, but in Europe, sovereigns are mostly seeing some demand with yields slipping 2bps-4bps across the board.  The one exception is, again, the UK, where Gilt yields are unchanged on the day.  Overnight, JGB yields were unchanged, while we saw lower yields across the rest of Asia which seemed to simply be following the Treasury market.

In the commodity space, Friday also saw oil prices rise 2%, and this morning they are essentially unchanged, consolidating those gains.  OPEC+ announced that they would continue their lower production levels which clearly has had a bigger impact than rumors that a ceasefire would soon be taking place in Gaza.  Gold is also little changed this morning, holding its gains while copper is edging higher, and aluminum is slipping.  There are many analysts who discuss the coming super cycle for commodities, but thus far, there is little consistency in the price action there.

Finally, the dollar is mixed this morning.  In the G10 we are seeing weakness from SEK (-0.65%), NOK (-0.35%) and JPY (-0.3%) although some strength from the euro (+0.1%) and pound (+0.2%).  Similarly, EMG currencies are seeing gainers (ZAR +0.4%) and laggards (CLP -0.8%) and everything in between.  If the new narrative of easier Fed policy turns into reality, then I would look for the dollar to suffer.  However, I don’t yet accept that as the case.

As mentioned above, there is much on the data front this week as follows:

TuesdayISM Services53.0
WednesdayADP Employment150K
 Bank of Canada Rate Decision5.0% (unchanged)
 JOLTS Job Openings8.9M
 Fed’s Beige Book 
ThursdayECB Rate Decision4.0% (unchanged)
 Initial Claims215K
 Continuing Claims1885K
 Trade Balance -$63.4B
 Nonfarm Productivity3.1%
 Unit Labor Costs0.6%
 Consumer Credit$10B
FridayNonfarm Payrolls200K
 Private Payrolls158K
 Manufacturing Payrolls10K
 Unemployment Rate3.7%
 Average Hourly Earnings0.3% (4.4% Y/Y)
 Average Weekly Hours34.3
 Participation Rate62.6%

Source: tradingeconomics.com

In addition, as well as Chairman Powell’s testimonies in Congress, there are another four Fed speakers, although with Powell headlining, I don’t think folks will pay too close attention to them.  Last week, the Fedspeak onslaught was very consistent about that lack of confidence that inflation would reach target soon, and there is clearly no hurry to cut rates, although virtually all speakers expect rate cuts to be the case.  Perhaps the data this week will change some minds, but remember, the big number doesn’t come out until after Powell speaks, and after Friday, the Fed enters its quiet period ahead of the next FOMC meeting.  

Right now, I have to believe last Friday’s data was the exception, not the rule, but we will learn more as the week progresses.  In the end, I think the dollar remains tied to the yield story, so as long as growth remains stronger here than elsewhere, and doesn’t show signs of falling sharply, the dollar should maintain its broad level of strength.

Good luck

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