Tag Archives: #Powell

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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The Doves Will Be Shot

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Inflation was just a touch hot

And certainly more than Jay sought

So, later today

What will the Fed say?

My sense is the doves will be shot



Instead, as Jay’s made manifest

Inflation is quite a tough test

So, higher for longer

Or language much stronger

Is like what he’ll say when he’s pressed






Let’s think a little outside of the box this morning, at least from the perspective of virtually every pundit and their beliefs about what will happen at the FOMC meeting today.  At this point, most of the punditry seems to believe that Powell cannot be very much more hawkish, especially since the market is expecting comments like inflation is still too high and the Fed will achieve their goal.  So, there is a growing camp that thinks any surprise can only be dovish, since if he doesn’t push back hard enough or talk about loosening financial conditions being a concern, the equity market response will be BUY STONKS!!!





But what if, the thing Powell really wants, or perhaps more accurately needs, is not a soft landing, but a full-blown recession!  Think about it.  As I have written repeatedly, the idea that the Fed will cut rates by 125bps next year because growth is at 1.5% or 2.0% and inflation has slipped to 2.5% seems like quite an overreaction.  But given the current US debt situation ($34 trillion and counting) and the fact that the cost of carrying that debt is rising all the time, what would get the Fed to really cut rates?  And the only thing that can do it is a full-blown, multiple quarters of negative GDP growth, rising Unemployment Rate, recession.  If come February or March, we start seeing negative NFP numbers, and further layoff announcements as well as declining Retail Sales and production data, that would get the Fed to act. 





At least initially, we would likely see inflation slide as well, and with that trend plus definitive weakness in the economy, it would open the door for some real interest rate cuts, 400bps in 100bp increments if necessary. Now, wouldn’t that take a huge amount of pressure off Treasury with respect to their refi costs?  And wouldn’t that encourage accounts all over the world to buy Treasuries so there would be no supply issues?  All I’m saying is that we cannot rule out that Powell’s master plan to cut rates is to drive the economy into a ditch as quickly as possible so he can get to it.  In fact, it would open the door to restart QE as well.





This is not to say that this is what is going to happen, just that it is not impossible, and I would contend is not on anyone’s bingo card.  Now, Powell will never say this out loud, but it doesn’t mean it is not the driving force of his actions.  Powell is incredibly concerned with his legacy, and he has made abundantly clear that he will not allow his legacy to be the second coming of Arthur Burns.  Instead, he has his sights on the second coming of Paul Volcker, the man who killed the 1970s inflation dragon.  St Jerome Powell, inflation slayer, is what he wants as his epitaph.  And causing a recession to kill inflation and then cut rates is a very clever, non-consensus solution.





How will we be able to tell if I’m completely nuts or if there is a hint of truth to this?  It will all depend on just how hard he pushes back on the current narrative.  Yesterday’s CPI results could best be described as ‘sticky’, not rebounding but certainly not declining further.  Shelter costs continue apace at nearly 6% Y/Y and have done so for more than 2 years.  I was amused this morning by a chart on Twitter (I refuse to call it X) that showed CPI less shelter rose at just 1.4% with the implication that the Fed needs to start cutting rates right away.  The problem with that mindset is that shelter is something we all pay, and there is scant evidence that housing markets are collapsing.  In fact, according to the Case Shiller index, they are rising again.  I would contend that there is plenty of evidence to which Powell can point that makes his case for an economy that is still running far too hot to allow inflation to slide back to their target.  And that’s what I expect to hear this afternoon.





Speaking of recession, let us consider the situation in China, where despite the CCP’s annual work conference just concluding with some talk of building a “modern industrial system” the number one goal this year, thus boosting domestic demand, they announced exactly zero stimulus measures to help the process.  Data from China overnight showed that their monthly financing numbers were all quite disappointing compared to expectations and the upshot was a further decline in Chinese and Hong Kong equity markets.  This ongoing economic weakness and the lack of Xi’s ability or willingness to address it continues to speak to my thesis that commodity prices will remain on the back foot.  If you combine the high interest rate structure in the G10 with a weaker Chinese economy, the direction of travel for energy and base metals is likely to be lower.  The one exception here is Uranium, where there is an absolute shortage of available stocks and a renewed commitment around the world to build more nuclear power plants.





At the same time, Europe remains pretty sick as well, with Germany leading the entire continent into recession, and likely dragging the UK with it.  Germany, France, Norway, the UK and others are all sliding into negative growth outcomes.  While Chairman Powell will continue to push back on the idea of rate cuts soon, I expect that tomorrow, when both the ECB and BOE meet, they will open the door to rate cuts early next year.  Inflation in both places has been falling sharply and there is no evidence that Madame Lagarde or Governor Bailey is seeking to be the next Paul Volcker.  Both will blink with the result that both the euro and the pound should feel pressure.





Summing it all up, today I think we get maximum hawkishness from the Fed with Powell pushing back hard on the market pricing.  Initially, at least, I expect we could see yields rise a bit and stocks sell off while the dollar continues its overnight rise.  But I also know that there are far too many people invested in the idea that the Fed must cut soon, and they will be back shortly, buying that dip until they are definitively proven wrong.  





As to the rest of the overnight session, aside from China’s weak performance, South Korea also lagged, but the rest of the APAC region saw modest gains.  Europe, meanwhile, is all green, although it is a very pale green with gains on the order of 0.2%, so no great shakes.  Finally, US futures are firmer by 0.1% at this hour (7:15) after yesterday’s decent gains.





Bond yields are sliding this morning, down 2bps in the US and falling further in Europe with declines of between -3bps and -6bps on the continent as investors and traders there start to price in a more aggressive downward path for interest rates by the ECB.  UK yields are really soft, -9bps, after GDP data this morning was disappointing across the board, especially the manufacturing data.





Oil prices (+0.45%) which got slaughtered yesterday, falling nearly 4%, are stabilizing this morning, as are gold prices, which fell yesterday, but not quite as much as oil.  However, the base metals complex continues to feel the pressure of weak Chinese demand.  I continue to believe that there are structural supply issues, but right now, the macro view of weak economic activity is the main driver, and it is driving prices lower.





Finally, the dollar is firmer this morning as weakness elsewhere in the world leaves fewer choices for where to park funds.  While the movement has not been overly large, it is quite uniform across both G10 and EMG currencies.  The laggards have been NZD (-0.6%) after a softer than expected CPI reading and ZAR (-0.6%) on the back of weakening metals prices.  If I am correct about the path going forward, the dollar should perform well right up until the Fed responds to much weaker economic activity and starts to cut rates aggressively.  At that point, we can see a much sharper decline in the greenback.





Ahead of the FOMC meeting, this morning we get November PPI (exp 1.0%, 2.2% core) which would represent a small decline from last month’s data.  We will also see the EIA oil inventory data, which has shown a recent history of builds helping to drive the oversupply narrative there.





At this point, it is all up to Jay.  I suspect that markets will be quiet until then, and it will all depend on the statement, the dot plot and the presser.





Good luck





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			No Matter What
		


				

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The story that’s got the most press

Is CPI’s sure to regress

So, Jay and the Fed

Without any dread

Can start cutting rates with success



But what if instead of a nought

The data is higher than thought?

Will markets adjust?

Or will folks still trust

That rate cuts come no matter what?






While all eyes truly remain on the FOMC meeting announcement tomorrow afternoon, and of course, the ensuing press conference by Chairman Powell, this morning brings the November CPI report, which could well have an impact on tomorrow’s outcome.  Current median expectations are for a M/M headline release of 0.0% leading to a Y/Y result of 3.1%.  As to the core (ex food & energy) result, M/M is forecast to be 0.3% with the Y/Y result being unchanged at 4.0%.





Lately, the inflation bulls, aka the deflationistas, have been harping on the fact that if you annualize the past 3 months’ worth of data or the past 6 months’ worth of data, the annualized outcome is 2.5% or lower, and so the Fed has basically done their job and returned inflation back to their target.  In the very next breath, they explain that with inflation back at target, they can start to cut rates because otherwise they will choke off the economy.





Even if I grant the first part of this thesis, of which I am suspect, it is the corollary rate cuts that make no sense at all.  Thus far, the bulk of the data that we have been observing has shown that the economy has held up extremely well despite 525 basis points of rate hikes over the course of less than two years.  This was made evident by Friday’s payroll report as well as the Q3 GDP report and much of the hard data that abounds.  Given the economy’s clear resilience to this higher rate structure, I can see no good case for the Fed to cut.





In fact, I think the key for the entire macroeconomic outlook revolves around just how long the US economy can maintain its growth trajectory with interest rates at their current levels.  The one thing of which we can be certain is that the Fed is not going to pre-emptively cut rates because they think a recession might show up, at least not now while inflation remains well above their target.  If the US economy continues to perform, meaning grow at 2%-2.5% over time while the Unemployment Rate stays below 4.5%, I would argue there is no incentive for the Fed to cut, at least not on a macro basis.  (There may be political reasons for them to cut, but that’s a different story.)  Now, if growth continues apace, will that be bullish or bearish for stocks?  For bonds?  For the dollar?  For commodities?  I would say that these are the questions we need to answer and are why the Fed remains such an important part of the discussion.  Do not discount a world where 10-year yields are 5.5%, Fed funds are 5.25% and GDP is 2.0% while inflation runs at 3.0%.  This could well be the near future.  It would also likely be quite a negative for risk assets.





My point is there continues to be a great dichotomy of thought as to how the future will unfold as we all are looking for the next clue to support our thesis.  While I continue to believe that a slowdown is coming, to date, there has been no clear evidence that is the case.  In fact, Friday’s Michigan Sentiment data was substantially better than anticipated while inflation expectations fell alongside the price of gasoline.  In fact, a marginally stronger than anticipated print this morning will simply be more proof that the market’s current anticipation for rate cuts in 2024, which sit between 4 and 5 cuts, will need to be repriced.  If risk assets have rallied on the basis of future Fed rate cuts, that could be a problem.  Just sayin’!





Ok, ahead of the data, this is what we have seen.  Yesterday’s modest US equity rally was followed by generally modest strength in Asia with the best performer being the Hang Seng (+1.1%).  Last night, China’s government made a series of announcements describing all the sectors of the economy that they would be supporting going forward with fiscal policy, although there were no numbers attached to any of it, it was all cheerleading.  Saturday night, Chinese CPI data was released at -0.5% both M/M and Y/Y, while PPI there fell to -3.0%.  The implication is that economic activity is not going very well.  In fact, it might be appropriate to define it as a recession, although I’m sure that won’t be the case.  However, looking for China to be the world’s growth engine may be a bad call for the time being.  As to Europe, it is a mixed picture there, with both modest gainers and modest laggards and no real direction overall.  US futures are higher by 0.2% at this hour (7:30) but are obviously keenly focused on the data release.





Yesterday’s bond market price action, where yields backed up, has been completely reversed this morning with 10-year Treasury yields lower by 5bps and European sovereign yields lower by even more, 6bps-7bps while UK gilts have really rallied, with yields there down by 12bps after the employment data showed wage pressures declining far more than anticipated.





On the commodity front, oil is drifting lower again this morning, down -0.6%, although the metals complex is showing strength with gains in gold (0.4%) and copper (0.3%), which seem to be rising on the back of a weaker dollar and lower US rates.  But a quick aside on oil and the commodities space in general.  I have made the point that the commodity markets are the only ones that are pricing in a recession.  And I would contend that is still the case.  Perhaps, though, I have been looking in the wrong place for that economic weakness.  Consider that China is the largest consumer of raw commodities in the world, by a wide margin.  Consider also that the Chinese economy is having all kinds of difficulty as the dash for growth seems to have reached its apex and is now sliding lower.  As I mentioned above, the idea that China is in a recession may not be absurd, and perhaps the fact that the commodity markets, in general, have been so soft is simply a recognition of that fact.  If this is the case, we need to watch Chinese economic activity closely in order to get a sense of the trend in commodities.  Or perhaps, we need to watch the trend in commodities to better understand the Chinese economy.  When base metals turn higher, look for Chinese stocks to do the same.





Finally, the dollar, as mentioned above, is under pressure this morning, down -0.3% when measured by the DXY.  The biggest mover is JPY (+0.7%) but we are seeing all the G10 bloc as well as the bulk of the EMG bloc rallying against the greenback.  Speaking of Japan, last night there was further commentary pushing back on the idea of any movement by the BOJ next Monday regarding the normalization of monetary policy in the near future.  I maintain that nothing will happen before they see the wage negotiation outcomes in March and, in the meantime, they are praying quite hard for the recent global inflation trend to remain downward as this will allow them to maintain their QE and fund the government.





And that’s really it for the day, as the CPI is the only news to be released.  Unless it is significantly different than the current expectations, I suspect that things will be quiet today, modest continued equity and bond rally as everybody places their bets that the Fed is getting ready to start to cut rates.  I’m not holding my breath.





Good luck





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			The New Allegory
		


				

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On Friday, the data surprised

With job growth more than advertised

So, bonds took a bath

And stocks strode a path

Where growth is what’s now emphasized



But what of the soft landing story?

Will rate cuts now be dilatory?

If Jay just stands pat

Will stocks all go splat?

Or is this the new allegory?






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





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





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





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





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





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





There’s no urgency

To change policy quite yet

But…some day we will






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





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





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





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





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





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





TodayNY Fed Inflation Expectations3.8%
TuesdayNFIB Small Biz Optimism90.9
 CPI0.0% (3.1% Y/Y)
 -ex food & energy0.3% (4.0% Y/Y)
WednesdayPPI0.1% (1.0% Y/Y)
 -ex food & energy0.2% (2.3% Y/Y)
 FOMC Rate Decision5.5% (unchanged)
ThursdayECB Rate Decision4.5% (unchanged)
 BOE Rate Decision5.25% (unchanged)
 Retail Sales-0.1%
 -ex autos-0.1%
 Initial Claims221K
 Continuing Claims1891K
FridayEmpire State Manufacturing2.0
 IP0.3%
 Capacity Utilization79.2%
 Flash PMI Manufacturing49.1
 Flash PMI Services50.5





Source tradingeconomics.com





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





Good luck





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			Jay Powell’s Dream
		


				

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As markets await the release

Of Payrolls, all things are at peace

But once it’s revealed

We need watch the yield

In 10-years lest it should decrease



While Goldilocks is still the meme

And certainly, Jay Powell’s dream

The data’s beginning

To show growth is thinning

More quickly both down and upstream






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





Nonfarm Payrolls180K
Private Payrolls153K
Manufacturing Payrolls30K
Unemployment Rate3.9%
Average Hourly Earnings0.3% (4.0% Y/Y)
Average Weekly Hours34.3
Participation Rate62.7%





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










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





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





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





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





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





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





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





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





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





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





Good luck and good weekend





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			Hawk-Eyed
		


				

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A landing that’s soft will require

A joblessness growth multiplier

Demand needs to slide

Enough so hawk-eyed

Fed members, rate cuts can inspire



The thing is, when looking at data

The trend hasn’t been all that great-a

While prices are falling

Growth seems to be stalling

More quickly than Jay’d advocate-a






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





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





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





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





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





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





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





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





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





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





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





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





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





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





Good luck





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			Too Clever by Half
		


				

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Said Jay, “it would be premature”

To think we’ve arrived at a cure

For higher inflation

Though there’s a temptation

By some to claim that we are sure



Instead, if we think it’s correct

More rate hikes we will architect

Investors, however,

Think Jay is too clever

By half and this view did reject






As we start a new week that will culminate in the payroll report on Friday, I think it is appropriate to consider how last week finished, notably how Chairman Powell left things leading into the Fed’s quiet period ahead of their next FOMC meeting on the 13th of this month.  To my ears, the two most important comments were as follows: “The strong actions we have taken have moved our policy rate well into restrictive territory, meaning that tight monetary policy is putting downward pressure on economic activity and inflation.”  A little later he explained, “It would be premature to conclude with confidence that we have achieved a sufficiently restrictive stance, or to speculate on when policy might ease. We are prepared to tighten policy further if it becomes appropriate to do so.”  





Now, interpretation is a subjective idea already, but FWIW my interpretation is he clearly understands they have tightened policy quite substantially, perhaps enough to achieve their goal of 2% inflation, but in a nod to this nation’s history, and ostensibly his hero, Paul Volcker, he is not going to get fooled by a temporary respite in inflation.  I believe he has made perfectly clear in the past that the Fed, or at least Chairman Powell, is willing to push the economy into a recession if he believes it is necessary to truly end inflation.





Of course, the biggest problem that he has is that the Fed is losing its ability to manage the situation as the Treasury continues to issue extraordinary amounts of new debt to fund spending.  This fiscal dominance results in a situation where the Fed’s actions have a diminishing impact on the macroeconomic variables they are trying to manage.  In fact, as I consider this situation it is actually a viable explanation for the fact that the market is very clearly ‘fighting the Fed’.  





One of the most common refrains from the post GFC period, when the Fed first introduced QE and kept repeating the exercise, driving asset prices substantially higher, although having very limited impact on goods and services inflation, was that investors, ‘don’t fight the Fed.’  The idea was that if the Fed was going to continue to print money, whatever the macroeconomic story was had limited impact on risk asset prices.  The Fed was the dominant factor and would continue to be so going forward. 





And that proved to be sage advice right up until the end of 2022.  The huge rally was supported by their easy money, and the reversal in 2022 was a result of them tightening policy substantially.  However, since then, and especially since the debt ceiling law was suspended until 2025, the Treasury has been able to issue as much debt as they like, and the government has been spending as quickly as possible.  While the Fed’s policy tightening was dramatic throughout 2022, it has slowed dramatically this year, and now it is being eclipsed, at least in a market response sense, by the flood of money entering the economy.  The result is that despite the Fed’s effort to maintain tight monetary policy, they are being overwhelmed by the Treasury’s profligate ways.  Hence, fighting the Fed is making sense.  It has largely worked in 2023 and while higher for longer may be the Fed’s mantra, it is being trumped by Yellen’s mantra of ‘issue another $1 trillion in T-bills just in case.’  





Setting aside, for a moment, the potential negative implications of the surge of Treasury issuance, its ability to crowd out private funding and therefore slow economic activity, from the market’s perspective, all those Federal dollars are being spent somewhere, and between the subsidies for ‘green’ energy, and the reshoring efforts across numerous manufacturing sectors, that money is circulating in the economy quite rapidly.  Since the government doesn’t really care what interest rate they pay (they will just borrow more to pay that interest), there is no financial brake on this activity.  It needs to be political.  And given there is a presidential election next year, the incentive for the incumbent administration to slow spending is not merely zero, it is negative.  





Ultimately, I believe this means that the Fed’s importance with respect to market movements overall is diminishing, although they will still have some impact.  Rather, I think we need to watch the spending plans more carefully.  One other thing to remember, especially for all the dollar bears out there, is that historically, a nation that runs tight monetary and loose fiscal policy winds up with a stronger currency.  This alone implies that news of the dollar’s demise may be greatly exaggerated.





Ok, while last week was all about Fed speak, this week is much more data focused.  Leading into the data dump, a look at markets shows that despite Friday’s strength in US equity markets, the rest of the world has been a little more suspect of things.  Both Japan and China saw weakness even though a court in HK ruled that China Evergrande had another 2 months to try to work things out before liquidation, although some other markets in Asia, notably India’s Sensex, (+2.0%) performed far better.  In Europe this morning, markets are mixed but I would argue are leaning slightly lower as both the FTSE 100 and CAC lower although the DAX and Spain’s IBEX are a touch firmer.  Finally, US futures at this hour (7:30) are pointing lower by about -0.35% across the board.





In the bond market, Treasury yields have backed up 5bps this morning, but are still at just 4.25%.  European sovereigns are also higher, albeit not quite as aggressively as Treasuries with the movement between 1bp and 3bps.  UK gilts are the outlier, also higher by 5bps.  Looking at Asia, while that 5bp rise was the norm Down Under, JGB yields are unchanged at 0.68%.  All this discussion regarding Japanese yields normalizing certainly seems to be premature at this stage.





In the commodity markets, oil (-0.6%) is slipping again as the response to the OPEC+ meeting has been less than impressive.  While production cuts were mooted, there is no clarity on which members will be cutting and by how much and for how long.  As we have been observing for the past months, the commodity market is the one that is truly pricing in a recession.  Equity markets are clearly on a different page although bond markets, given the magnitude of last month’s move, have certainly taken notice that things are slowing down.  In the metals markets, gold is little changed from Friday’s levels this morning, although Friday saw a sharp 1.5% rally.  As well, I would be remiss if I didn’t mention that in the overnight session, gold exploded to a new all-time high of $2135/oz before retracing those gains.  There is a growing interest in the barbarous relic, especially with the market’s growing belief that the Fed and other central banks are going to be cutting rates soon.  The rest of the metals complex, though, is under pressure this morning, once again pointing to concerns over a recession in the near future.





Finally, the dollar, overall, is slightly higher although there has been a mix in the components.  Notably, the yen strengthened sharply on Friday after the Powell comments but the same cannot be said of either the euro or the pound.  In fact, both of those currencies, as well as the rest of the European bloc, are under pressure as there is a growing certainty that Europe is entering, or perhaps already in, a recession, and the central banks there are going to be cutting rates soon.  As to the EMG currencies, today is a broadly dollar strength day and we are seeing virtually all of them under pressure vs. the greenback.  As I mentioned above, tight monetary and loose fiscal policies are a recipe for a currency’s strength.





Ok, let’s turn to the data story.





TodayFactory Orders-2.8%
TuesdayISM Services52.0
 JOLTS Job Openings9.35M
WednesdayADP Employment128K
 Trade Balance-$64.1B
 Nonfarm Productivity1.9%
 Unit Labor Costs-0.9%
ThursdayInitial Claims2223K
 Continuing Claims1940K
 Consumer Credit$9.0B
FridayNonfarm Payrolls180K
 Private Payrolls155K
 Manufacturing Payrolls25K
 Unemployment Rate3.9%
 Average Hourly Earnings0.3% (4.0% Y/Y)
 Average Weekly Hours34.3
 Participation Rate62.7%
 Michigan Sentiment62.0





Source: Tradingeconomics.com





So, a huge amount of new data with ISM to start the week and NFP to finish.  Perhaps there will be a decisive trend that implies either recession is coming soon or not at all but based on everything we have seen over the last 6 months, at least, I imagine there will be both hot and cold data to absorb.  Fortunately, there are no Fed speakers although keep your eyes peeled for a WSJ article from the current Fed whisperer, Nick Timiraos, if things start to point to even more aggressive rate cuts by the Fed next year (5 cuts are already priced starting in March).  





For today, my take is the market seems likely to take a breather after a remarkable risk rally last month.  Absent any real new news today, look for a quiet one.  But we need to watch the data this week carefully for clues as to whether the goldilocks or recession narrative will dominate.  Funnily enough, in either case, I feel like the dollar is likely to hold its own.





Good luck





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			Nirvana Sans Prayer
		


				

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The Fed has regaled us this week

With speakers who all tried to tweak

Their message on rates

And foster debates

On havoc their actions might wreak



Some told us their hiking was done

That, as to inflation, they’d won

But others explained

They’d not yet obtained

Relief from this price rising run



Now into this breech steps the Chair

Who later this morning will share

His views where they stand

And how he has planned

To reach rate nirvana sans prayer






As we enter the final month of 2023, the bulls are in the ascendancy.  The 60/40 portfolio, which had been declared obsolete last year and certainly behaved that way most of this year, just had its best month since 1985.  US equity markets rallied between 8%-10% and 10-year Treasury yields fell 40bps through the month.  In other words, the price of virtually everything went higher.  This includes gold (+3.0%), silver (+10.5%) and copper (+5.0%) with only oil (-7.5%) and the dollar (DXY -2.5%) as the losers in November.   





To what do we owe this remarkable performance across asset classes?  Or perhaps the question should be to whom do we owe this outcome?  My vote is for goldilocks!  Her story of everything winding up ‘just right’ remains the dominant market narrative.  This has been encouraged by a plethora of Fed, and other central bank, speakers harping on the fact that inflation readings continue to decline nicely, and although nobody is ready, yet, to begin cutting interest rates, there seems to be an implicit wink, wink, nod, nod that the market is sensing rate cuts are coming soon.  And maybe they are, but that is certainly not my base case.





However, my base case is not relevant here, the market viewpoint is the driver.  Interestingly, yesterday we heard from NY Fed President Williams and while he has been encouraged over the recent path of inflation readings, when asked about the market’s pricing of rate cuts early next year he explained, “he wasn’t losing any sleep over the issue.”  In other words, he is unconcerned with the market chatter and is focused on the data and his perception of the economy’s performance.  In fact, I believe that to be the case for all the FOMC members, despite the prevailing narrative that the Fed will never surprise the market if they can avoid doing so.





This brings us to this morning’s speech by Chairman Powell.  His is the last communication by a Fed member ahead of the FOMC meeting on the 13th.  At this point, it remains unknown if he will hew toward the idea that things look good and they have reached an appropriately tight level of monetary policy and financial conditions, or if he will try to continue with the higher for longer concept, highlighting that while progress has been made, the dangers of easing prematurely are grave and must be avoided at all costs.  The fact that Governor Waller, earlier this week, expressed that it might be appropriate for rates to decline in 3-4 months’ time has the equity and bond bulls pawing the ground and ready to charge again.  However, I would contend that Williams’s comments yesterday, indicating little concern over market pricing and greater concern that they finish the job to be just as important.  Powell clearly listens to both these gentlemen closely.  In the end, the one thing that Powell has explained time and again is that he will not make the Arthur Burns mistake of easing before inflation was well and truly dead.  It is this consistency in his communications that leads me to believe that the bulls are a bit ahead of themselves for today.





Remember, too, we will see the NFP report next Friday, and the November CPI report the day before the FOMC announcement, as well as a bunch of other data to help fill in some blanks.  In fact, yesterday’s PCE data, both headline and core, were right on expectations as was virtually everything else except Continuing Claims, which at 1927K, was the highest since early 2022, and another sign that the labor market is loosening up.  Countering that, though was a dramatically higher than expected Chicago PMI print of 55.8, pointing to strong growth.  Again, the data continues to lack a unifying direction at this stage.  And so, regardless of Powell’s comments today, the FOMC will still have much to digest before they decide.





As to how this will impact markets, my take is the following: goldilocks is still the predominant narrative which means that weaker economic data will be seen as bullish news for both stocks and bonds because it will cement the view that the Fed is not only finished but that cuts are coming soon.  Correspondingly, strong data will be much harder to swallow as it will renew concerns that the Fed is not done hiking yet.  But until Powell speaks this morning at 11:00, we are in the dark.





Reviewing the overnight activity shows that equity markets in Asia were mostly lower with the Hang Seng (-1.25%) continuing to feel the pressure of the weak Chinese property market.  The story is that China Evergrande has until Monday to avoid liquidation with further potential ramifications for other property developers.  Alas, President Xi has not been able to find a Chinese solution for taking on too much debt and blowing a bubble that does not include popping that bubble.  As to Europe, after a strong November in equity markets there as well, this morning is seeing gains across the board on the order of +0.7% while US futures are currently (8:00) ever so slightly softer, -0.2%.





In the bond market, after a rip-roaring month around the world as the prevailing narrative grew that the peak in inflation, and therefore, yields has been seen, this morning is starting off quietly.  The yield on the 10yr Treasury is higher by just 1bp and in Europe, we are actually seeing modest yield declines, 1bp-2bps, as investors respond to still weak PMI data across the continent.  While the uber-hawks on the ECB are unwilling to discuss rate cuts, given the slowing growth in the Eurozone and the fact that inflation readings there are declining much more rapidly than in the US, the market is quite confident that rate cuts are coming soon.





Oil prices are slightly softer this morning, -0.5%, which takes them right back to where they started the week.  However, they have fallen for the previous 5 weeks.  The OPEC+ meeting was something of a dud, with what appears to be a further production cut, but there was certainly no unanimity of action there.  Gold prices are unchanged on the day, maintaining most of their recent gains and copper prices (+0.6%) are actually edging higher again.  To the extent that copper is an accurate harbinger of future economic activity, it certainly seems that prospects are improving and a recession will be avoided.





Finally, the dollar, which has seen universal hatred based on the decline in 10yr Treasury yields as well as the narrative that the Fed is going to be cutting rates early next year, continues to hold its own.  In fact, it is slightly firmer in the past week overall, although we have seen a mix of movements depending on the currency.  Among the weakest has been the euro, which while it peaked above 1.10 earlier this week for a brief time, is now back below 1.09 as traders start to understand that whatever the Fed may do with interest rates, the ECB is going to be cutting sooner than the Fed.  At the same time, we have seen some strength in the commodity bloc over the past week, with AUD, NZD, CAD, NOK and ZAR all showing solid performances on the back of the recent commodity strength.  





And lastly, we cannot ignore the yen, the currency that everyone was certain was set for a major rally as the diverging paths of the Fed (imminent cuts) and the BOJ (ending QE and tighter money) would finally change the trend.  Oops!  While the yen is a bit stronger this week, about 0.8%, that barely covers the negative carry of the position and with 10yr JGB yields back in the 60bps range, there is really no evidence that Japan is actually preparing to tighten policy.  While I personally think they do need to start doing so as inflation has remained above their 2% target for more than a year, things work differently in Tokyo than elsewhere.  For hedgers, I have to believe that JPY puts are the best protection around, relatively inexpensive and allowing for any significant rallies in the yen without locking in bad rates.





Leading up to Powell’s speech this morning, we see ISM Manufacturing (exp 47.6) although after yesterday’s blowout Chicago PMI number, don’t be surprised to see a bit higher.  Canadian Employment data was just released, largely in line with expectations as the Unemployment Rate ticked up to 5.8% as forecast.  Again, we continue to see a mixed picture with regard to the future of the economy.  I think that is why we put so much stock into central bank speakers, but also why things remain so confused.  After all, they don’t have any better models or insight than the rest of us and are just winging it anyway!





Big picture is, if Powell is hawkish and pushing back on the narrative, I expect the dollar to edge back higher.  However, if he does not push back, look for another serious equity and bond rally and for the dollar to sink.





Good luck and good weekend





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			Gradually Growing
		


				

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Two giants have recently passed

Who both, did a century last

Charles Munger went first

Whose wit was well-versed

Then Kissinger, quite the contrast



Meanwhile, recent data is showing

Economies worldwide are slowing

But pundits still think

The world will not sink

Instead t’will keep gradually growing






If there is any truth to the concept that things happen in threes, keep your eyes peeled for another well-known individual to pass away soon.  In the past week, both Charlie Munger, Warren Buffet’s partner at Berkshire Hathaway, and the one with the sharp wit, passed at 99 and, last night, Henry Kissinger passed away after 100 years on this earth.  Both were highly accomplished and extraordinary individuals, and the world is a lesser place for their passing.  May they rest in peace.





But back to the market saga, or perhaps it is the economic saga, that we have been both watching and through which we are living.  The soft-landing narrative remains strong as we continue to see economic activity data slide slowly lower, although it is certainly not collapsing.  In fact, that is the whole point, the idea that the central banks have been able to engineer a sufficient slowdown in growth such that inflation pressures recede but economic activity remains strong enough so unemployment doesn’t rise too far.  While historically this has been a very rare occurrence, perhaps they will achieve it this time.





If we are to look at the recent data, certainly the forward looking data, it certainly seems like growth is slowing.  We can ignore yesterday’s upward revision in Q3 GDP as that is already behind us, although it is impressive in its own right.  But for things that are more current, or the surveys that look ahead like PMI, the news is not quite so robust.  For instance, yesterday saw weakness in Spanish Retail Sales, Swedish Business Confidence and Eurozone Industrial Sentiment.  Overnight, we saw weaker Korean IP and Retail Sales, weak Japanese Retail Sales, a further decline in Australian Building Permits and Chinese PMI data continuing to slide with Manufacturing slipping to 49.4 and Non-Manufacturing falling to 50.2, both the lowest levels in a year.  The point is, looking all around the world, the trend is pretty clearly for slowing economic activity.





The flip side of this story is the one that the central banks are really watching, the inflation situation, and there the central banks are starting to feel better.  Eurozone CPI was released this morning with headline falling to 2.4% and core to 3.6%.  Given the declines in CPI we have seen this month around the world (remember energy prices fell sharply), this should be no surprise.  And of course, later this morning we will see the Fed’s favorite, Core PCE (exp 0.2% M/M, 3.5% Y/Y).  While this reading remains well above their target, the trend has clearly been beneficial of late.





This idea has been largely reinforced by central bank speakers this week, notably with Chris Waller’s comments on Tuesday that in a few months, if inflation continues this trend, it could be time to cut rates, but also mostly from the other speakers, with even uber-hawk Mester, yesterday, saying the Fed is in a good place to wait and watch.  Talk of additional hikes if inflation resurfaces is scarce now and the market is really looking for Chairman Powell to reiterate that message when he speaks tomorrow morning at 11:00.  But the market will not wait for confirmation, they are already onboard with the message as it suits the narrative of BUY STONKS!  So, we have seen Fed funds futures rally further with the market now looking for 125bps of cuts by the end of 2024 with a 50/50 chance of the first coming in March.  Wow!





So, how should we think about this situation?  To me, there are two issues with which to contend.  First, my take is much of the CPI decline is due to energy and the one really sticky piece of inflation, at least in the US, the price of housing, is not showing any signs of declining.  I think the Case Shiller Home Price index remains the best measure and it is continuing to go higher.  While existing home sales have been crashing, it is because of a lack of supply, not a lack of demand.  So, prices remain firm, and that is going to feed into inflation data for a while.   My point is, while recent readings have shown CPI falling, we remain well above target, and I expect that we are going to stay above target, although not anywhere near where things were last summer.





The second thing is that as evidenced by the litany of weaker data we are seeing around the world, economic activity is pretty clearly slowing everywhere.  In this situation, waiting for the Fed to cut first may be a mistake as other central banks may find themselves with more dire economic circumstances before the US gets there.  And, if that is the case, all the bearishness that is building around the dollar because of the renewed belief the Fed is going to cut rates soon could well be misplaced.  Remember, the FX markets are relative, so if the ECB cuts before the Fed, that seems unlikely to help the euro.  The same is true with the BOE or BOC or any other central bank.  My point is, while the dollar has retraced some of its recent gains on the belief the Fed is ready to cut, even if the Fed does cut, they will not do so in isolation.





Remember, too, the wise words from Hemingway’s The Sun Also Rises.  “How did you go bankrupt?  Two ways, gradually and then suddenly”.  It is very possible, if not likely, that we are currently in the gradually phase of economic slowdown, with the suddenly phase yet to come.  Just beware.





Ok, in the meantime, a quick look at markets shows that after another lackluster session in the US, Asian markets were able to rally a bit with the Hang Seng and mainland indices shaking off the weak PMI data while European bourses are clearly benefitting from the soft CPI data this morning out of Frankfurt.  At this hour (7:45) US futures are also a bit firmer, about 0.4% or so.





In the bond market, yields are rebounding a bit with Treasury yields up 4bps and European sovereigns a little less dynamic, higher between 1bp and 3bps.  However, we have come a long way this month, with 10yr Treasury yields down 64bps, their largest monthly decline since 2008.  My take is we will need to see confirmation from Powell tomorrow for there to be another leg lower in yields, but if he pushes back, look for a few fireworks there.





Oil prices are continuing their rebound as OPEC+ is meeting, up another 1% this morning and 4% on the week.  The whispers are another production cut is coming, and we also have seen the inventory builds slow down.  Meanwhile, gold is slightly softer this morning, but remains well above $2000/oz with many looking for a test of that all-time high at $2080.  As to the base metals, they are under a bit of pressure, which given the economic data, makes some sense.





Finally, the dollar is firmer this morning, recouping about 0.4% of its recent losses with strength largely across the board.  Ultimately, relative interest rates remain the key driver in this space and for now, while dollar yields have declined, they have not done so in isolation.  As such, until they start to fall more sharply than rates elsewhere, I think the dollar will be treading water in a range.





On the data front, aside from PCE we also see Personal Income (exp 0.2%), Personal Spending (0.2%), Initial Claims (220K), Continuing Claims (1872K) and Chicago PMI (45.4).  We hear from John Williams this morning as well, so it will be interesting to see if he backs up the recent shift of the Fed is done and things are going well.





My take is Williams will, indeed, hew that new line and we will see a bit more positivity in equities and bonds while the dollar fluctuates and perhaps gives up some of this mornings gains.  But really, all eyes are on Powell tomorrow.





Good luck





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			Talk the Talk
		


				

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It seems that investors are waiting
For Powell, and so they’re debating
Will he be a hawk
And still talk the talk
Or will he be accommodating?

The punditry seems unpersuaded
Another rate hike could be slated
So, most views expressed
Say; time to invest!
And bearish ideas must be faded






It is almost as if we are still on holiday given the lack of price movement across most markets so far this week.  In fact, other than the Chinese markets (Hang Seng -1.0%), which are continuing to suffer from the ongoing implosion of their property bubble, market activity yesterday in the US, overnight through the rest of Asia and in Europe this morning has been quite muted.  Perhaps the tone has been very mildly bearish, with declines on the order of -0.25% or so, but that comes in the wake of gains as much as 10% or more through the month of November.  As such, it should be no surprise to see a bit of portfolio rebalancing.  Certainly, there is a lot more discussion about the soft/no-landing scenario and we are beginning to see S&P 500 prognostications for the end of 2024 being above 5000.  





The premise seems to be that inflation has been defeated, and that while the Fed may wait a few more months before cutting rates, by this time next year they will be celebrated for having achieved the elusive soft-landing.  The implication is that once they are more comfortable that inflation is dead, they will start to cut rates because…?  And that is where I get lost.  If the economy continues to grow with rates at 5%, exactly why should the Fed consider cutting them?  The only reason I can see is that the pressure from the administration grows too intense as the cost of refinancing the currently outstanding and growing debt continues to rise dramatically.  The problem with this outcome, however, is that if the Fed is seen to be cutting rates under pressure from the administration to reduce financing costs, it is likely to signal to the market that fiscal policy is in complete control (yesterday’s discussion on fiscal dominance is apropos here).  Historically, when that happens, inflation is not merely, not dead, it is ready to roar.





The implications of this policy direction are unlikely to be welcome in government, in boardrooms or in households, as rising inflation and a declining currency are a toxic mix for economic success.  Let’s think this through before cheering it on.





As we progress toward the 2024 presidential election, it is abundantly clear that the federal government is going to seek to spend as much money as possible.  Not only that but I am confident they learned the lessons from the GFC and Covid that QE simply pumps up asset prices while helicopter money is far more effective in getting cash into the hands of the voters.  Given the recent surveys that show 80% of the country believes they are worse off than prior to President Biden’s election, the recipe to address this is quite clear; give more money directly to the people.  And so, you can be sure that there will be numerous fiscal giveaways as 2024 unfolds.





The problem is that these giveaways do not create organic growth in the economy, rather they are the antithesis of organic growth.  As such, tax revenues will continue to lag, and the deficit will continue to grow ever larger.  Already, the cost of funding the outstanding ~$34 trillion in debt has reached $1 trillion, more than the government spends on defense, the largest non-entitlement program.  As well, the average tenor of US Treasury debt continues to decline with almost half needing to be refinanced by the end of 2025.  If interest rates remain at 5.5% and the Treasury continues to skew toward T-bills rather than coupons, that $1 trillion bill is going to grow to $2 trillion pretty quickly.  That will require even more debt issuance to repay, and the cycle will grow ever larger and faster.





It doesn’t take much imagination to see where this could be headed and there is a history of how it has worked in the past, notably with Weimar Germany in 1921-1923 and more recently, in Zimbabwe in 2008-2009 and again in 2019, and, of course, Argentina today.  The classic response to this problem is to institute yield curve control so that those debt payments are contained.  Of course, that means that government debt will pay negative real yields, and the Fed will wind up owning most of it*.  The natural consequence here will be that the dollar will likely decline sharply, at least against ‘real’ stuff like commodities, and a little less-so against quasi-real stuff** like equities.  Versus other currencies it is much harder to tell because if the US is in this situation, other countries are likely to be in difficult straits as well, so the FX value of the dollar may not collapse.  Of course, other countries may not have the same debt dynamics as the US, and those currencies will likely hold up better than the rest.





My fear is this is the new direction of travel.  It is not a given by any stretch, but it is going to seem quite attractive to politicians of every stripe, regardless of their political affiliation or ostensible principals because, remember, to an elected politician, the most important policy is one that gets them re-elected and they will vote for anything that they believe will help them in that cause, principals be damned. 





Will this have any impact today?  Very unlikely.  But it is important to remember this possible path as we await to hear more Fed speakers, but notably Chairman Powell on Thursday morning.  Any hint that the pressure to cut is working (and I am sure there is plenty of pressure for that from Treasury and the executive branch) and we will see a massive rally in equities, bonds and commodities as the dollar declines.  At least at first.  In fact, it is for this reason that I believe that we are going to hear much more hawkish rhetoric from all the Fed speakers this week, and that Powell will be particularly so.  They understand the potential ramifications of capitulation and are not yet ready to allow it.





As to today’s markets, bond yields are within 1bp of yesterday’s closes but leaning lower right now, US equity futures are basically unchanged as are gold and the entire metals complex although oil is edging higher on the news that Saudi Arabia is pushing for another 1mm bbl/day production cut at Thursday’s OPEC+ meeting.





On the data front, yesterday’s New Home Sales data was quite weak, with both prices and volumes falling.  This morning we see Case Shiller Home Prices (exp 4.0%) and Consumer Confidence (101.0) and we hear from four Fed speakers, Goolsbee, Waller, Bowman and Barr.  Look for that hawkish tilt.  It is also supomatsu, the day when spot FX settles on month end, so I expect FX volumes to pick up a bit, but historically, this is more of a swap exercise than a directional one, and so looking for directional movement based on this would be a mistake in my view.  





If I am correct and hawkishness is the Fed mantra today, I expect the dollar will be able to edge a bit higher along with yields, but until Powell speaks, I suspect we will remain fairly muted overall.





Good luck





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*There is another possibility with regards to ownership of treasury debt to prevent the Fed from owning all of it, new rules can be instituted that require banks, insurance companies and even your 401K or IRA accounts to maintain a certain percentage of assets in treasury bonds.  So, in the latter case, which has already been discussed in Washington, you could see 20% or 30% of your retirement next egg forced into negative real yielding assets for a long time.  I assure you that will not help your retirement situation!  





** I use the term quasi-real stuff as equities represent shares in a real business, so there is underlying value to that business and its assets, although not quite the same as owning the actual hard assets they represent.