Tag Archives: #Powell

Nary a Doubt

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The two things we’re watching today
Are Jay and the new QRA
The pundits are out
With nary a doubt
That easing is coming our way

But what if this faith is misplaced
And Jay, at the presser, bald-faced
Says policy ease
Is not what we please
And we’ll not get there in great haste

Reading the Fed Whisperer, Nick Timiraos of the WSJ, this morning was enlightening only to the extent that everybody he interviewed demonstrated they have no idea what will happen, and merely described what they would like to see.  Now, in fairness, I don’t think Powell himself really knows how things are going to play out as we continue to see mixed pictures on the economy.  For every strong datapoint (e.g., GDP, JOLTS, Case Shiller) indicating that there are many potential inflationary pressures extant, we see some softer data points (e.g., PCE, Empire Manufacturing, Dallas Fed) that indicate policy is excessively restrictive.  While it is very clear that the Fed will not adjust policy today, a look at Fed funds futures shows that the market is pricing in a 45% chance of a cut in March.  A month ago, that was over 70%, so Powell must be a bit happier, but 6 weeks is such a long time in this context, anything can happen between now and then.  And, oh yeah, the market is still pricing in 6 cuts this year.

Of course, long before the FOMC statement and Powell presser this afternoon, the Treasury will release its QRA and the market will learn if Secretary Yellen is going to continue down her recent path of leaning toward more T-bills and less coupons.  Based on her continuous comments that the soft landing has been achieved and inflation is no longer a problem, it seems quite clear that she wants to see the Fed cut rates soon.  After all, lower interest rates take pressure off the budget deficit, which is entirely her baby at this point.  Interestingly, she could essentially force Powell’s hand in this situation as follows:

1.     Issuing a high percentage of T-bills will lead to
2.     Reducing the RRP balances and bank reserves which will
3.     Force the Fed to respond by slowing/ending QT to prevent any systemic problems like seen in September 2019

Remember, we have already heard from Powell, as well as Dallas Fed President Lorie Logan, whose previous role was at the NY Fed overseeing the Fed’s reserve portfolio, that the time to discuss slowing or ending QT was fast arriving.  By itself, that is a policy ease, but it would also be a signal that further changes were on their way.  In fact, a continued heavy reliance on T-bill issuance would have two vectors to support the bond market; ending QT reduces the amount of bonds the market needs to absorb and reducing new supply by itself will do exactly the same thing.  At least for as long as inflation remains quiescent.  And in the end, that remains the biggest unknown, inflation.  All these plans and ideas revolve around the premise that the Fed has won its inflation fight.  But I ask you, what if they haven’t?

Too much digital ink has been spilled already on the inflation question and the two camps remain at distinct odds.  Forgetting all the conspiracy theorists who claim inflation is really 10% or more, and looking only at serious economists and analysts, while all agree that the rate of inflation has fallen from its peak levels in the summer of 2022, there is still a pretty even split between the two sides.  While I fall on the side of stickier inflation than the market is pricing, I can understand the other side of the story.  But the point is, there are two very real sides to the story and the outcome remains unwritten.  However, if inflation does remain stickier than the doves believe, it will destroy their entire thesis of why the Fed should be easing policy.  Given the stock market is making new highs regularly, I suspect investors and traders have largely bought into the ‘inflation is over’ view.  Just be careful if it’s not.

Ok, as we await today’s activities, let’s look at what happened overnight.  Following a mixed session in the US yesterday, Asian markets turned back the clock a few weeks with the Nikkei (+0.6%) continuing its longer-term rally while both the Hang Seng (-1.4%) and CSI 300 (-0.9%) revert to their losing ways.  It seems that investors simply do not believe that President Xi has either the ability or willingness to do anything to support the stock market there, at least, if not the economy.  I believe it would be a mistake to believe he is not willing, which calls into question exactly what they are going to do to prevent things from starting to impact the economy more negatively.  And perhaps we have seen the first steps.  The other noteworthy story in the WSJ this morning was about how Chinese authorities are “discouraging” negative takes on the economy from being published and instead telling news outlets to publish stories about the bright prospects there.

Moving on to Europe, the main indices have moved very little thus far today after a mixture of data showing inflation in Germany and France continue to decline but Retail Sales in Germany (-1.6%) and Switzerland (-0.8%) and Industrial Sales in Italy (-1.0%) all falling sharply in December.  Given the weak GDP data yesterday on the continent, none of this can be surprising.  Finally, US futures are mostly lower this morning, led by the NASDAQ (-1.0%) despite (because of?) what seemed to be solid earnings from Microsoft and Alphabet.  In the end, though, I sense that investors are far more focused on the QRA and FOMC right now.

Treasury yields are unchanged this morning but that is after a 4bp decline yesterday and we have seen European sovereign yields slide this morning as well, between 1bp and 3bps, which seems to be a catch up move to the Treasuries.  I must mention Australian government bonds, which saw yields tumble 13bps overnight on the back of a much softer than expected CPI reading which has the market talking rate cuts there again.  Finally, JGB yields edged 2bps higher, despite weaker than expected Retail Sales and IP data.

Oil prices (-1.1%) are backing off this morning after another positive day yesterday and a very strong month of January, where WTI rose > 9%.  (My take is that will not help the CPI data when it comes out in a few weeks’ time.)  Meanwhile, metals prices are trading near unchanged on the day as traders here are also awaiting the new information.

It should be no surprise that the dollar is, net, little changed this morning on the same premise of waiting for Godot Powell.  Looking at my screen, I don’t see any currency that has moved more than 0.3% in either direction so really no information yet today.

In addition to the QRA and FOMC meeting, we see the ADP Employment Report (exp 145K), the Employment cost Index (1.0%) and Chicago PMI (48.0).  Careful attention should be paid to the ECI as the Fed focuses on that metric for wage inflation data.  As an indication, prior to the pandemic, that index averaged around 0.6%, but since then, it is more like 1.0% on a quarterly basis.  That annualizes to more than 4% and will maintain upward pressure on inflation if it stays there.  Just something else to keep in mind.

If pressed, I believe that the QRA will show reduced coupon issuance and Powell will be more dovish than not.  While we know the Treasury is political, by definition, and will do everything in its power to stay in power and get re-elected, my take is the Fed is in that camp as well.  I would not be surprised to see a more dovish take this afternoon after the QRA this morning.  And initially, at least, that tells me the dollar will trade back toward its recent lows ceteris paribus.

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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Some Shocks

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While many still seek goldilocks
The problem is we’ve seen some shocks
Inflation won’t fall
And oil’s in thrall
To US and UK war hawks
 
But if we adhere to the data
It’s really not looking that great-a
For those who think Jay
Will soon lead the way
By cutting the Fed’s funding rate-a

We are back to being inundated with new information from both economic data and global events, both of which are driving markets for now.  Interestingly, depending on the asset class, it seems that some are studiously ignoring what this new information means, at least what it has historically meant.

Let’s start with yesterday’s CPI data, which printed higher than forecast on both the headline (3.4%) and core (3.9%) measures.  One needn’t be a market technician to look at the chart below of annualized CPI over the past five years and consider the possibility that the downtrend has ended, and we are reversing higher.

Source: tradingeconomics.com

To the extent that financial data has trends, and I think that is a very realistic estimate of how things work, the Fed may have a much tougher time squeezing the last 1.0% – 1.5% out of the inflationary process than many seem to believe.  At least many in the bond market seem to believe that as despite the hotter than expected CPI data, bond yields actually declined yesterday.  As well, there is no indication from the Fed funds futures market that they have changed their view on the number of rate cuts coming in 2024 with an even higher probability of a March cut, > 70% this morning, and still 6 cuts priced in for the entire year.  

Regarding this seeming dichotomy, it is almost as if the market is trying to force the Fed’s hand.  Historically, the Fed has tried not to ‘surprise’ markets when it comes to decisions, keeping a close eye on market pricing on the day of each meeting.  As such, if the market is pricing in a cut or a hike, the Fed has been highly likely to follow through in the past.  When there have been disagreements, the Fed will typically roll out lots of speakers to get their view across before the meeting in order to prevent that surprise on meeting day.  As well, it is very clear that there is virtually no expectation of a rate adjustment at the FOMC meeting on January 31st, so perhaps the Fed doesn’t feel it is warranted to be that concerned yet.  And of course, the data may turn in the direction of much softer inflation and even modestly worse employment so a cut will become the de facto norm.  But my point is, the March 20th meeting is just 67 days away.  For an economy whose trends move very slowly, it seems like the market may be a bit ahead of itself in this case.

We did hear from three Fed speakers yesterday, Mester, Barkin and Goolsbee, all of whom indicated that while the broad direction of things seemed pretty good, a rate cut in March is very premature.  In fact, that has been the consistent theme from every Fed speaker and the market just doesn’t seem to care.  We will see two PCE reports, two more CPI reports and two more NFP reports before the March FOMC meeting.  And they will all be part of Q1 data, not Q4 data, so will at least have more relevance to the current situation.  Maybe the market is correct, and inflation is going to turn back lower, and the first signs of economic weakness will convince Powell and friends it’s time to preemptively cut rates.  However, even if that turns out to be the case, it is hard for me to see that as a > 70% probable outcome.  Of course, I am just an FX poet, so maybe I just don’t get it.

The other topic that is making an impact is the Middle East.  You may recall that oil prices had been on the soft side as the market saw weakening demand due to an impending recession with massive supply gains coming from better and better producer efficiency.  In fact, I wrote about the latter this past Sunday in Oil’s Price is not Rising.  However, all that efficiency is unimportant when compared to the escalation that we saw last evening in the Middle East, where US and UK forces attacked Houthi positions in Yemen in retaliation for the Houthi attacks on shipping in the Red Sea.  This morning, oil is higher by 3.5% and since Monday, the rise has been 6.6%.  

This poses several problems overall.  First, of course, is the widening of the Middle East conflict being a problem in and of itself.  The US military is already straining with its mission given the number of different places US troops are in harm’s way throughout the Middle East and Asia.  The one thing we have learned throughout history is that war is inflationary.  So, escalations in fighting will ultimately lead to escalations in prices of many things.  Oil is merely the first casualty.  

If you are Jay Powell whose current mission is to reduce inflationary pressures, a widening military conflict is not going to help the situation.  In fact, it is likely that he will be called upon to support the military by ensuring the Treasury can issue as much debt as necessary at reasonable prices.  This means the end of QT and a restarting of QE.  If that were to be the case, and that is a big if, inflation would start another strong leg higher, and markets will be greatly impacted.  Commodity prices will rise, the dollar will likely weaken, a bear steepening for bond yields would be in the cards and equity markets would rally, at least initially.  But it would throw out any ideas of low inflation.  I am not saying this is the current expectation, just that it is something that needs to be considered as events unfold going forward.

A quick look at the impact on markets today shows that equity markets are non-plussed by the escalation as yesterday’s benign US performance was followed by another rally in Japan although Chinese shares continue to lag after a big data dump showed economic activity there remains export oriented into a slowing global growth situation.  Inflation remains moribund there, the Trade Surplus grew, and domestic funding continues to grow at a slower and slower pace.    In Europe, though, there does not seem to be much concern as equity indices are all higher by about 0.5% although US futures are suffering a bit, -0.35%, at this hour (7:45).

In the bond market, Treasury yields are 3bps higher this morning than yesterday’s close, although they remain right at 4.00%, so are not really moving very much right now.  Meanwhile, European sovereign yields, which closed before the US yields declined late, are all down about 3bps this morning, helped by confirmation that final inflation readings in Europe remained at recent lows.  In the UK, the net data dump showed slightly weaker than forecast IP and GDP data which has helped drive the bid in Gilts. A quick JGB look, where yields fell 2bps, revolves around a story that the BOJ is going to reduce its end of year inflation forecast thus reducing the probability of any policy change anytime soon.  This is one of the things helping the Nikkei and also a key driver of USDJPY higher.

Aside from oil prices rising, we are seeing gold (+1.0%) on the move today on the back of the Middle East escalation although the base metals are mixed.  One other commodity note is uranium, a market which has been getting a lot more love lately given the recent acceptance by a portion of the eco community that its ability to generate electricity without producing CO2 is a net benefit.  40 nations have promised to increase their nuclear power use and demand for uranium has been rising amid a market where there is very limited supply and annual production does not meet current annual demand, let alone projected future demand.  I simply wanted to highlight that there are price movements all over the place and while uranium may not be a major contribution to inflation, the fact that its price is rising so rapidly (100% in the past year) is not going to push inflation lower.

Finally, the dollar is firming up this morning as risk assets come under pressure.  This is a typical war footing, where investors flee to the dollar in times of stress, just like they flee to gold.  While the movement thus far has not been substantial, just 0.3% on average, it definitely has room to move further if things deteriorate in the Red Sea.

On the data front, we see PPI this morning, expected 0.9% headline, 2.0% ex food & energy, although given CPI was released yesterday, I doubt it will matter very much.  As well, we hear from Minneapolis Fed president Kashkari, so it will be interesting to see if he has a different take than March is too soon, but things seem to be going well.

As we head into the weekend, the Middle East is the wild card.  If things heat up, look for oil prices to continue to rise and risk to be discarded.  That will probably help the bond market for now, and the dollar, but stocks will suffer.

Good luck and good weekend

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Jay’s Coronation

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The word for today is inflation
With many convinced its cessation
Is just round the bend
So, growth will ascend
Alongside Chair Jay’s coronation
 
But what if inflation don’t slow?
And rather, continues to grow
Can bonds stand the pain?
Will stocks feel the strain?
Or will we go on with the show?

The first thing to mention is the Bitcoin ETF was approved by the SEC last evening and the price…is basically unchanged.  As I mentioned yesterday, it seems quite ironic that Bitcoin, a shining symbol of freedom from the government and regulation is now tightly ensconced in government and regulation.  Do not be surprised if it becomes a much less interesting asset having lost one of the key things that makes it different.  Just a thought.

Ok, on to the more important stuff, the economy and today’s CPI report.  Current consensus forecasts are as follows: CPI 0.2% M/M (3.2% Y/Y) and -ex food & energy 0.3% M/M (3.8
% Y/Y).  If realized, these represent a 0.1% rise in the headline and 0.2% decline in the core readings from last month on an annual basis.  Now, in the broad scheme of things, and more importantly, in our day-to-day lives, that 0.1% or 0.2% has absolutely no meaning or impact.  However, the importance allotted to that 0.1% is remarkable.  Entire narratives will be spun about how the Fed has been amazing in their ability to achieve a soft landing, or the Fed is a group of 17 incompetent fools based on an estimated data point that is often revised and does not clearly measure what the words in its name describe.  As such, let’s simply focus on the market reaction function rather than the meaning of the data.

Heading into the release, my take is that given the recent run of softer than forecast inflation readings around the world, whatever the economists and analysts have forecast, the market is leaning toward a soft print.  The fact that oil prices fell about -6% during the month of December, although gasoline prices were nearly unchanged, has tongues wagging.  As well, discussions about slowing growth in China and their negative PPI as a driver of deflation is another key element of the narrative. 

Counter to this is the fact that the Fed refuses to take their victory lap.  Yesterday, John Williams explained, “My base case is that the current restrictive stance of monetary policy will continue to restore balance and bring inflation back to our 2% longer-run goal.  As inflation comes down over time, my expectation is interest rates will also come down over time.”  In other words, things are going well, but we have not reached the finish line.  This certainly didn’t sound like someone who was ready to cut interest rates in two months’ time although the market continues to price a better than 2/3 probability that the Fed will do just that.  Now, if we take him at his word and inflation fell another 0.6% or more by March, maybe that would be enough to get them into a cutting mood.  But I just don’t see that.

One of the things that is often either overlooked or not well understood is the fact that things move REALLY slowly in the economy, especially when it comes to measured moves of economic data points.  Of course, the exception that proves this rule was the Covid recession, but in order to get data to move at the same speed as markets required virtually every government in the world to shut their economies down at the point of a gun!  My take is that will not happen again in our lifetimes, regardless of the threat.  As such, we need to recognize that, to use a well-worn metaphor, the economy is an aircraft carrier and turning it takes time.  

When applying this concept to inflation, and prices more generally, especially wages, they don’t move that quickly.  In fact, they move quite slowly.  People get annual raises, not weekly or monthly ones.  While gasoline prices move up and down on a daily basis, the same is not true for menu prices, items in the supermarket or rent.  Real-time price adjustments are a flaw feature of financial markets, not of real life.  While many will point to the fact that the shelter portion of CPI (and PCE) is a smoothed average of the past twelve months and so not indicative of today’s situation, I would counter that most of the people who pay rent haven’t moved in the past twelve months and their rent remains the same.  It is certainly not declining, and I am still looking for that first story of the landlord who saw the CPI data slipping and cut his tenants rent to keep in line!  

The point is that expectations of a sharp move in a slow-moving data series are misplaced.  Much has been made of the fact that if you annualized the last 3 months or 6 months of CPI monthly data, CPI is already below the Fed’s target of 2.0% and so they should be cutting.  Personally, I find that ridiculous.  But more importantly, the Fed, as evidenced by Williams’ comments above, has no truck with that idea.  Add to this the fact that growth seems to be holding in at trend or better, despite interest rates being “too high” according to the cutting advocates, and it becomes that much harder to believe the Fed is ready to go.

Net, regardless of today’s number, the Fed is not going to change its mind soon.  Markets, however, are a different story.  If the readings are soft, look for a big rally in both stocks and bonds, for the dollar to fall, and for commodity prices to rally nicely.  At least initially.  And the converse should be true as well, a hot number will see red numbers in the stock market, higher yields, a stronger dollar and commodities come under pressure.

Leading up to the number, here’s what we see.  After a nice day in the US yesterday, Asian markets were all in the green led by the Nikkei continuing its rip higher, but this time dragging Chinese shares along for the ride.  In Europe, it appears things are more circumspect as they await the CPI data with most markets +/- 0.2% or less on the day while US futures are currently (7:30) modestly in the green.

Bond yields are definitely in the low inflation reading camp as Treasury yields have fallen 4bps this morning and we are seeing similar movement all across Europe.  The one exception to this story is Japan, where JGB yields edged higher by 2bps despite a couple of soft Leading Economic Index numbers.  However, since the peak, just below 1% in early November, this trend remains clearly lower for yields.

Apparently, the hijacking of an oil tanker in the Persian Gulf has been seen as an escalation of the situation there and oil prices are higher by nearly 2% this morning, although that simply takes the weekly change back to flat.  Gold prices are rallying, 0.5%, and not surprisingly in this environment, so are base metals prices with both copper and aluminum higher by 0.6% this morning.

Finally, on the dollar front, it is lower after a small decline yesterday.  This is of a piece with the inflation expectation story and the idea that the Fed is preparing to cut rates, boost stocks and undermine the dollar.  Even the yen has rallied a bit today, so no currencies are really bucking the trend of a weak dollar, whether G10 or EMG.

Aside from the CPI data, as it’s Thursday we also see Initial (exp 210K) and Continuing (1871K) claims and then early this afternoon we hear from Tom Barkin again.  At this stage, the Fed seems to be of a mind that things are going well, and they are not about to rock the boat in either direction.  Absent a huge surprise in the data this morning, I think this slow grind toward risk on continues.

Good luck

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Magical Stuff

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

 

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

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

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

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

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

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

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

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

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

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

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

Good luck

Adf

Somewhat Miffed

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The Minutes did naught to explain
Why Jay might need raise rates again
But if we all harken
The Fed’s Thomas Barkin
The future seems cloudy with rain
 
So, now it seems Jay’s somewhat miffed
As he and his team try to shift
The views he expressed
That rate cuts were blessed
And markets did act sure and swift

 

Remember the certainty with which market participants determined that the Fed had not only finished raising interest rates, but that they would be cutting them quite soon?  That is so last year!  It seems that after a powerful Santa Claus rally that was inaugurated by Secretary Yellen’s move to issue more T-bills and less coupons, and then seemingly confirmed at the December FOMC meeting, where the dot plot showed no more rate hikes and a median expectation of three cuts this year, and where Chairman Powell, when given a chance to push back on this new narrative in the press conference, went out of his way to embrace the ‘rate cuts coming soon’ narrative, the Fed is no longer happy about the situation.  Instead, now they seem to want the market to ratchet back these expectations for a quick decline in interest rates.  At least, that’s what we heard from Richmond Fed president Tom Barkin yesterday, “The FOMC’s December meeting got a lot of attention. We acknowledged the progress on inflation and explicitly reaffirmed our willingness to hike if necessary.”  [emphasis added].

Meanwhile, the Minutes seemed to lean more hawkish than not, “It was possible that the economy could evolve in a manner that would make further increases in the target rate appropriate.  Several also observed that circumstances might warrant keeping the target range at its current value for longer than they currently anticipated.”  Arguably the best line, though, was “Participants generally perceived a high degree of uncertainty surrounding the economic outlook,” which is likely the most honest statement they have ever made.  In the end, the Minutes didn’t sound very dovish to me, but as I mentioned above, the press conference came across far more dovishly.  One other thing to note is that they mentioned QT for the first time in quite a while.  It seems that they recognize the incongruity of shrinking the balance sheet while cutting interest rates, so they have begun to consider how to message any changes there.

With this new information being absorbed, the market is now in the process of re-evaluating the idea that rate cuts are going to happen as quickly and as substantially as thought just a week ago.  At this time, there is just a 10% probability of a cut at the end of this month (it was nearer 20% last week) and the March probability is down to 70% (it was 79% last week) though the market is still pricing in 6 cuts in 2024.  FWIW, that seems outside the bounds of how things will ultimately play out, and I maintain that while a cut could easily be made by the May meeting, I do not foresee inflation cooperating which will force a lot of rethinking.

To summarize the Fed story, the market has sensed a disturbance in the easing force that had been widely assumed and a key driver of the late 2023 risk rally.  This morning, markets have stabilized after two consecutive negative days to open the year.  As such, let us keep our eyes peeled for more, new and, potentially non-narrative, information going forward. 

Looking at the latest data releases overnight and this morning, they consisted of the Services PMI data as well as German state inflation.  Regarding the former, both Australian and Japanese data were soft although Chinese data was better than expected with the Caixin Services PMI printing at 52.9, continuing its rebound from summer lows.  Across Europe, Italian (49.8), French (45.7), German (49.3) and the Eurozone composite (48.8) all showed contractionary numbers although the UK (53.4) vastly outperformed.  As to the German state-by-state inflation readings, every one of them bounced sharply from last month’s recent lows and the market is looking for a sharp rebound in the national CPI to 3.7% later this morning.  As I have written before, that combination of rising inflation and weak growth is a tough situation for Madame Lagarde.  My money is still on her to address the growth rather than the inflation, although she will likely wait until the Fed moves before doing so in Frankfurt.

With all this in mind, let’s take a look at the overnight market activity.  In Asia, the picture was mixed although there was more red than green on the screen.  While the Nikkei (-0.5%) fell, other Japanese indices held their own, and we saw some strength in Indian shares as well.  However, China remains under pressure, despite the stronger than anticipated PMI reading and that has been weighing on South Korea, Hong Kong and Australia overall.  However, in Europe, we are seeing modest gains this morning, only on the order of 0.1% or 0.2%, but green is more pleasant than the red of the past two days.  As to US futures, they are little changed at this hour, although again, better than their recent performance.

In the bond market, from the time I wrote yesterday morning, yields fell through the rest of the session by nearly 7bps in the 10yr Treasury market, and this morning, they have bounced back from the closing levels by 4bps.  We have seen similar price action throughout Europe where yesterday’s declines to closing lows have been reversed and we are now between 6bps and 9bps higher than the end of Wednesday’s session.  JGB yields, though, remain anchored at 0.60%, unchanged.

Oil (+1.0%) is continuing to rebound as the situation in the Middle East seems to be getting more complex.  The Houthis continue to attack Red Sea shipping, Israel killed a Hezbollah leader in Lebanon, potentially widening the conflict and there was a terrorist bombing in Iran (with the best guess it was internally executed by an unhappy faction) which can only serve to increase the overall tension levels.  While the broader weakness we have seen in this space is likely a response to weaker overall economic activity, especially in China, at some point, that activity will pick up and I expect oil prices to do so as well.  In the metals complex, base metals are under further pressure this morning, with both copper and aluminum down -0.6% or so, although gold (+0.2%) is bucking that trend, perhaps on the back of the dollar’s marginal weakness this morning.

Speaking of the dollar, as measured by the DXY it is -0.2% softer this morning with pretty uniform losses vs the major G10 and EMG currencies.  The one exception is the yen (-0.6%) which continues to suffer based on the idea that the BOJ will not be able to consider interest rate normalization in the wake of the recent earthquake on the country’s west coast.  In truth, the dollar seems to be quite the afterthought in markets right now, with much greater focus on the bond market and central bank actions as the drivers.  While I would carefully watch if the dollar starts to break these correlations, I don’t see it as a key driver right now.

On the data front, we see a few things this morning, starting with ADP Employment (exp 115K) and then Initial (216K) and Continuing (1883K) Claims.  As well the Services PMI data is released later this morning (51.3) and finally we get the EIA oil inventories with another large draw of 3.7 million barrels expected which ought to continue to support the black, sticky stuff.

There are no Fed speakers on the calendar although we must all be watchful for the pop-up CNBC interview if they feel their message, whatever it may currently be, is not getting proper attention.  While the first two sessions of the year were certainly uncomfortable for risk assets, I do not believe that my idea of a solid first half followed by more evident problems in the second half of the year has been dismantled.  Clearly, tomorrow’s NFP data will be critical, and we will discuss it ahead of the release.  Until then…

Good luck

Adf

Dragged Through the Mud

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The year started out with a thud
As equity markets saw blood
The bond market fell
And oil’s death knell
Was sounded, whilst dragged through the mud
 
The question we now must address
Is, are markets set to regress?
Or, is this a blip
O’er which we can skip
Without adding too much new stress?

 

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

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

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

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

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

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

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

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

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

On the data front, we see the following:

TodayISM Manufacturing47.1
 ISM Prices Paid47.5
 ISM Employment 46.1
 JOLTS Jobs Openings8.85M
ThursdayADP Employment115K
 Initial Claims216K
 Continuing Claims1883K
FridayNonfarm Payrolls168K
 Private Payrolls130K
 Manufacturing Payrolls5K
 Unemployment Rate3.8%
 Average Hourly Earnings 0.3% (3.9% Y/Y)
 Average Weekly Hours34.4
 Participation Rate62.7%
 ISM Serv ices52.6
 Factory Orders2.1%

Source: Tradingeconomics.com

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

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

Good luck

Adf

Chairman Powell Has Struck Out

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(With apologies to Ernest Lawrence Thayer)

The outlook’s quite uncertain for the ‘conomy this year
As there are those with strong belief the future’s bright and clear
But just as many seem to take a different view instead
And what they see is awful, with recession dead ahead.

The key discussion centers on inflation and its course
And whether central bankers, tighter money still endorse.
The bulls believe the Fed is done, with rate cuts coming soon
Thus, other central banks will quickly sing that selfsame tune.

The bears, however, see that global structures have now changed,
With tariffs and near-shoring rising, free trade’s now estranged.
The upshot is the bears believe that higher’s still for longer
As pricing pressures bubble thus, inflation grows much stronger.

The funny thing about this split in views is that both sides
May find that for a time this year their views will be good guides.
I think the bulls will run the show for quarters one and two
But as the year progresses weaker outcomes will come due.

Now let’s consider how the year is likely to begin;
With visions of soft-landings leading bulls to go all-in.
They see inflation sliding down to two or even one,
As yields on 10-year bonds fall back to Three before they’re done.

In sync with this they’re certain that the Dow and S&P
Will make new highs o’er 40K and 5K ‘spectively.
The dollar, in this view, has seen its highs for years to come
And so, they think the DXY, to Ninety-Five, will plumb.

This means the euro ought to trade as high as One Two-Oh
While dollar yen descends below One Thirty midst great woe
The pound is like to rise above One Forty in this wave
And pesos and reals explode as these, investors, crave.

The final data point for Goldilocks to make her case
Is oil needs to settle here and simply stay in place.
So, while good growth ought help support demand for Texas Tea
More oil will be pumped by nations recently set free.

This means the current policies where sanctions have relaxed,
Will show that barrels pumped will not have waned, but rather waxed.
And one last thing, the price of gold, will rally to new highs
As low real rates and central banks will lead gold bears’ demise.

I must admit that this sounds great if it can last all year
Alas, there are some issues which are likely to appear.
Come summer solstice cracks in this façade will start to show
And as the year winds down I fear unhappiness will grow.

The causes, proximate, will have to do with lags in time
As rate hikes o’er the past two years have changed the paradigm.
And though we’ll surely see the Fed and ECB respond
Twon’t be in time to stop the selling of the ten-year bond.

Instead, as growth conditions slacken each and every day,
The rate cuts will not be enough to halt the growth decay.
As well, a problem central banks are likely still to face
Is that inflation will go back above their target pace.

Stagflation is an awful word as it describes a state
Where prices rise too fast while growth just cannot germinate.
And this, dear friends, is what I fear will come to pass this year
By Christmas, bonds and stocks will fall while metals hit high gear.

So, what can we expect as Twenty-Four plays out in time?
The second half is likely to create a different clime
Than what we saw through June, when everything was filled with cheer
And stocks made record highs with greed ascendant over fear.

Instead, as summer turns to fall, inflation will come back
And late Q3 Chair Powell will have started to backtrack,
So rather than more rate cuts a new message will be sent
A pause, or maybe rate hikes are the future fundament.

This news will not be taken by the markets with aplomb
Instead, the first half rally will collapse like Pets.com.
And with inflation creeping higher Jay will have to choose
Twixt prices or the market, either way he’s sure to lose.

Some folks believe the ‘lection in November will impact
The Fed, though Jay will surely claim their mandate’s what they’ve tracked;
Now, if they fight inflation then the Dems will surely scream
But if they help the markets rise, poor Jay, the Pubs, will ream.

This means we need look deeply into Powell’s inner thoughts
And see if Arthur Burns or Chairman Volcker calls the shots;
My money’s on the tall one which means tighter policy
As only that can help cement Jay’s hero’s legacy.

With this in mind we’re like to see stocks peak sometime in June
And for the rest of Twenty-Four we’ll watch those markets swoon.
So, from the heights, Dow Forty K and Five K S&P
To Thirty K and Three-point-Five K Spooz, I do foresee.

As to the bond, despite the fact that growth will be lackluster,
Inflation won’t cooperate and so, Jay will be flustered.
While we may see one Fed funds cut before the summertime
The back end of the market will reverse, and yields will climb.

Come Christmas time I see the bond will yield ‘bout Five point Five
And all those levered bets are not too likely to survive.
As to the dollar, it should find its footing in the summer
And start to rise, which for the shorts, will really be a bummer.

So, think about a euro back ‘neath One Oh-Five or less;
And Dollar Yen above One Fifty, midst Ueda’s stress,
As poor Kazuo will not get to normalize his rates
And so, investment from Japan will flow back to the States.

The pound will suffer too, as like in Europe, growth will lag
And so, below One Twenty t’almost certainly will sag.
Emerging market currencies will have a better run
As rates are more supportive and no cuts need be undone.

In fact, when winter solstice on the calendar appears
Reals and pesos won’t have moved from where they closed last year.
Let’s now turn to the stuff that we can touch and see and smell;
Commodities like oil, though, for not too long we’ll dwell.

In concert, and a reason for inflation’s resurrection
Demand for oil only goes in one long-term direction.
So, more demand will drive the price back to One Hundred bucks
And if a wider war breaks out its June ‘Oh Eight redux.

The final price that I foresee in this unnerving tale
Is gold which ought to sparkle as most fiat moneys fail.
The Relic that’s called Barbarous will head above 3K,
And after this there’s just one thing I’ve really left to say.

Oh, somewhere in this great big world the sun is shining bright;
The ‘conomy is growing and inflation’s very slight.
But here at home stagflation is what Jay has brought about
There’ll be no joy in ‘Twenty-Four, Chair Powell has struck out!

To all my readers near and far, please know my sole intent
Is offering my viewpoint and it always is well-meant.
So, as we all embark upon Two Thousand Twenty-four
I thank you all for reading, for its you I all adore.

Thanks and Happy New Year
Adf

Sufficiently

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

‘Bout dovishness seen over there

Though I’m not omniscient

We need rates sufficient-

Ly high til inflation is rare



The Old Lady’s governor, too

Expressed that no cuts were in view

But can both withstand

More slowing than planned

And, with their tough talk, follow through?

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

Good luck, good weekend and have a wonderful holiday

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Miles Off Base

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This poet was miles off base

As Powell, more growth, wants to chase

So, hawks have been shot

With nary a thought

While doves snap all stocks up apace.



It seems clear that Jay and the Fed

Decided inflation is dead

Through Q1 at least

Bulls will have a feast

Though after, take care where you tread

It turns out that not only were my tail risk ideas wrong, I was on the wrong side of the distribution!  Powell has decided that the soft-landing narrative is the best estimator of the future and wants to make sure the Fed is not responsible for a recession.  Concerns over inflation, while weakly voiced, have clearly dissipated within the Eccles Building.  I hope they are right.  I fear they are not.

In fairness, once again, yesterday I heard a very convincing argument that inflation was not only going to decline back to the Fed’s target of 2.0%, but it would have a 1 handle or lower by the middle of 2024 based on the weakening credit impulse that we have seen over the past 18 months.  And maybe it will.  But, while there is no question that money supply has been shrinking slowly of late, which has been a key part of that weakening credit impulse story, as can be seen from the chart below based on FRED data from the St Louis Fed, compared to the pace of M2 growth for decades, there are still an extra $3 trillion or so floating around the economy.  Iit seems to me prices will have a hard time falling with that much extra cash around.

Of course, there is one other place that money may find a home, and that is in financial assets.  So, perhaps the outcome will be a repeat of the post-GFC economy, with lackluster growth, and lots of money chasing financial assets while investors lever up to increase returns.  My guess is that almost every finance official in the world would take that situation in a heartbeat, slow growth, low inflation and rising asset prices.  The problem is that series of events cannot last forever.  As is usually the case with any negative outcome, the worst problems come from the leverage, not the idea.  When things are moving in one’s favor, leverage is fantastic.  But when they reverse, not so much.

A little data is in order here.  According to Statista, current global GDP is ~$103 trillion in current USD, current global stock market capitalization is ~$108 trillion, and the total amount of current global debt is ~$307 trillion according to the WEF.  In a broad view, the current debt/equity ratio is about 3:1 and the current debt/sales ratio is the same.  While this is not a perfect analogy, usually a debt/equity ratio of 3.0 is considered pretty high and a company that runs that level of debt would be considered quite risky.  Now, ask yourself this, if economic activity only generates $108 trillion, how will that >$300 trillion of debt ever be repaid?  The most likely answer is, it never will be repaid, at least not on a real basis.

If you wonder why central bankers favor lower interest rates, this is the primary reason.  However, at some point, there is going to be more discrimination between to whom lenders are willing to lend and who will be left out because they are either too risky, or the interest rate demanded will be too high to tolerate.  When considering these facts, it becomes much easier to understand the central bank desire to get back to the post-GFC world, doesn’t it?  And so, I would contend that Chairman Powell has just forfeited his efforts to be St Jerome, inflation slayer. 

The implication of this policy shift, and I would definitely call this a policy shift, is that the near future seems likely to see higher equity prices, higher commodity prices, higher inflation, first higher, then lower bond prices and a weaker dollar.  The one thing that can prevent the inflation outcome would be a significant uptick in productivity.  While last quarter we did see a terrific number there, +5.2%, the long-term average productivity growth, since 1948 is 2.1%.  Since the GFC, that number has fallen to 1.5%.  We will need to see a lot more productivity growth to keep goldilocks alive.  I hope AI is everything the hype claims!

Today, Madame Christine Lagarde

And friends are all partying hard

Now that Jay’s explained

Inflation’s restrained

And rate cuts are in the vanguard



This means that the ECB can

Lay out a new rate cutting plan

The doves are in flight

Which ought to ignite

A rally from Stuttgart to Cannes

Let’s turn to the ECB and BOE, as they are this morning’s big news, although, are they really big news anymore?  Both these central banks have been wrestling with the same thing as the Fed, inflation running far higher than target, although they have had the additional problem of a much weaker economic growth backdrop.  As long as the Fed was tightening policy, they knew that they could do so as well without having an excessively negative impact on their respective economies.  But given that pretty much all of Europe is already in recession, and the UK is on the verge, their preference would be to cut rates as soon as possible.  

But yesterday changed everything.  Powell’s bet on goldilocks has already been felt across European markets, with rallies in both equity and bond markets in every country.  The door is clearly wide open for Lagarde and Bailey to both be far more dovish than was anticipated before the FOMC meeting.  And you can be sure that both will be so.  While there will be no rate cuts in either London or Frankfurt today, they will be coming soon, likely early next year.  

At this point, the real question is which central bank will be cutting rates faster and further, not if they will be cutting them at all.  My money is on the ECB as there is a much larger contingent of doves there and the fact that Germany and northern European nations are already in recession means that the hawks there will be more inclined to go along for the ride.  Regardless, given the Fed has now reset the central bank tone to; policy ease is ok, look for it to happen everywhere.

Right now, this is all that matters.  Yesterday’s PPI data was soft, just adding fuel to the fire.  Inflation data that was released this morning in Sweden and Spain saw softer numbers and while Retail Sales (exp -0.1%, ex autos -0.1%) are due this morning along with initial Claims (220K), none of this is going to have a market impact unless it helps stoke the fire.  Any contra news will be ignored.

Before closing, there are two things I would note that are outliers here.  First, Japanese equity markets bucked the rally trend, with the Nikkei sliding -0.7% and the TOPIX even more (-1.4%) as they could not overcome the > 2% decline in USDJPY yesterday and the further 1% move overnight.  That very strong yen is clearly going to weigh on Japanese corporate profitability.  The other thing is that there is one country that is not all-in on the end of inflation, Norway.  This morning, in the wake of the Fed’s reversing course, the Norges Bank raisedrates by 25bps in a total surprise to the markets.  This has pushed the krone higher by a further 2.3% this morning and nearly 4% since the FOMC meeting.  

As we head toward the Christmas holidays and the beginning of a new year, it seems like the early going will be quite positive for risk assets and quite negative for the dollar.  Keep that in mind as you consider your hedging activities for 2024.

Good luck

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