Too Clever by Half

Posted on December 4, 2023 by fxpoet

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 13^th 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.

Today	Factory Orders	-2.8%
Tuesday	ISM Services	52.0
	JOLTS Job Openings	9.35M
Wednesday	ADP Employment	128K
	Trade Balance	-$64.1B
	Nonfarm Productivity	1.9%
	Unit Labor Costs	-0.9%
Thursday	Initial Claims	2223K
	Continuing Claims	1940K
	Consumer Credit	$9.0B
Friday	Nonfarm Payrolls	180K
	Private Payrolls	155K
	Manufacturing Payrolls	25K
	Unemployment Rate	3.9%
	Average Hourly Earnings	0.3% (4.0% Y/Y)
	Average Weekly Hours	34.3
	Participation Rate	62.7%
	Michigan Sentiment	62.0

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

Adf

Nirvana Sans Prayer

Posted on December 1, 2023 by fxpoet

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 13^th. 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

Adf

Gradually Growing

Posted on November 30, 2023 by fxpoet

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

Adf

Talk the Talk

Posted on November 28, 2023 by fxpoet

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

Adf

*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.

Clearly the Rage

Posted on November 27, 2023 by fxpoet

While AI is clearly the rage
Where Mag 7 try to engage
Consider the fact
That during this act
They’re fighting each other backstage

Just a little aside regarding the situation in equity markets, which in the US really means the Magnificent 7 these days. One of the key features of their cumulative success was that these companies had no significant overlap regarding their business models. Online shopping, iphones, EV’s, search, GPUs, streaming services and a social network clearly intersected to some extent, but the main focus of all these companies was spread out in different directions. Yes, Amazon prime competes with Netflix, as does Apple TV, and yes, Amazon Web Services, Microsoft Azure and Google Cloud are all in the same business, but there is a huge amount in that particular segment that is still unfulfilled, so competition but not cutthroat.

But AI is a different kettle of fish. All of them are actively investing in their own AI programs and working to integrate them into their current services and products. And we are already seeing announcements of new GPU’s to directly compete with Nvidia and bring that supply chain in-house for the other users. The point is, there is going to be a lot more investment, if not overinvestment, in this space with, arguably, quite a while before whatever AI does starts to really help the bottom line. In other words, do not be surprised to see margins start to decline in these companies which is unlikely to help drive their share prices higher. As well, with investment focused on this new area, we need to expect to see a reduction in share repurchases, removing one of the key bids to the market.

All I’m saying is that even in a soft or no landing scenario, it strikes me that the Magnificent 7 may be running out of room to continue their amazing run of share price gains. And if they start to stumble, just the very nature of the equity indices, where their capital weightings are so large combined, > 30%, I suspect the indices themselves may find themselves under a lot of pressure, regardless of whether the Fed cuts rates or not. And if the Fed cuts rates because the economy is slipping into recession, or has already gotten there, that cannot be good for margins either. While timing is everything in life, this is something that needs to be on everyone’s radar, because it will change the risk narrative, and that matters for all markets. Just sayin’.

While last week was mercif’ly free
Of Fedspeak, the FOMC
This week will explain
Again and again
Why higher for longer’s the key

As the market returns to full strength, at least from a staffing perspective, post the Thanksgiving holiday, things are opening fairly quietly. A quick recap of the data since I last wrote shows that the mix of good and bad continues to leave prospects uncertain going forward. This has allowed both the soft/no landing camp and the recession camp to point to specific things and claim they are on the right track. So, Durable goods were pretty lousy in October and Michigan Sentiment also fell sharply, but Initial Claims fell as well, indicating that the labor market remains robust overall. In other words, uncertainty continues to reign.

One of the interesting things is that different markets appear to be pricing very different outcomes. For instance, commodity markets, or at least energy markets, are clearly in the recession camp as oil prices remain under pressure, falling another 1.5% this morning as the market awaits the outcome of Thursday’s delayed OPEC+ meeting. Talk is that there could be another 1 million bbl/day production cut to help support prices, but nothing is yet certain. At the same time, both copper and aluminum remain under pressure, sliding a bit further last week and this morning while gold (+0.5%) is back firmly above $2000/oz, hardly a sign of a positive future.

However, as dour as the commodity markets feel, equity markets remain quite resilient overall. Although this morning, we are seeing modest declines around the world, with European bourses lower by -0.2% or -0.3%, and US futures are currently (8:00) down by -0.15%, the month of November has been a big winner almost everywhere. Gains, ranging from 5% – 11% are the order of the month as equity investors have gone all-in on the idea of a soft landing and that the major central banks are going to be slowly reducing interest rates to ensure economic growth continues.

In truth, bond markets are of a similar mind as equities with 10-year yields lower by between 25bps and 40bps during November throughout the G10 (Japan excepted but even there lower by 10bps). Clearly, all this can be traced back to the QRA released back on November 1^st when Treasury Secretary Yellen let it be known that there would not be as much coupon issuance as had been anticipated, and that more of the Federal government’s borrowing would take place in the T-Bill market. That was the starting gun for the bond market rally and the ensuing stock market rally.

So, which of these two views is correct? That, of course, is the $64 trillion question, and one with no clear answer yet. As I have written numerous times, and as we saw last week, the data continues to be mixed, with both positive and negative signs. While the Fed, and virtually every other G10 central bank continues to harp on the idea that they will not be cutting rates anytime soon, markets are pricing in rate cuts starting in early Q2 of 2024.

Ultimately, there will be a winner of this battle, but the game is still afoot. FWIW, while I have long been concerned that the imbalances in the economy were going to lead to a more significant correction in equity prices, there is another side to the story that is worth exploring, and that is the concept of fiscal dominance.

According to the St Louis Fed, a good definition of fiscal dominance is: “…the possibility that accumulating government debt and deficits can produce increases in inflation that dominate central bank intentions to keep inflation low.” The corollary here is that the Fed is losing its power over one of its key mandates, stable prices, because the Federal government’s fiscal impulse is so great as to overwhelm the Fed’s actions.

With 2024 a presidential election year, and with the TGA currently at $725 billion plus negotiations for more spending on Ukraine, Israel and the southern border, there will be no shortage of additional Federal moneys flowing into the economy. Add to this the fact that the surge in T-Bill issuance will move savings from a “dead zone” in the standing RRP facility, which is still at $935 billion, to more active money, able to be used in the real economy, and it is easy to see how economic activity is going to be supported throughout 2024. Whatever your views on the appropriateness of these policies, the reality on the ground is that the current administration will do everything in its power to be re-elected and that includes spending as much money as possible. Remember, too, that there is no operable debt ceiling, so they can issue as much debt as they want to fund whatever they can get legislated.

If the Fed has lost control of the narrative, and it does appear to be slipping through their fingers, then we will need to start to focus elsewhere to find market drivers. Of course, if the Fed is losing its grip, do not think for a moment they will go meekly into the sunset. Instead, I could see several more rate hikes as they continue to try to fight for price stability amid an economy flush with cash. In other words, this story is nowhere near finished.

At this point, let’s take a look at this week’s data, which will bring updated GDP and PCE readings amongst other things.

Today	New Home Sales	723K
	Dallas Fed Manufacturing	-17
Tuesday	Case Shiller Home Prices	4.0%
	Consumer Confidence	101.0
Wednesday	Q3 GDP	5.0%
	Goods Trade Balance	-$85.7B
Thursday	Initial Claims	220K
	Continuing Claims	1872K
	Personal Income	0.2%
	Personal Spending	0.2%
	Core PCE	0.2% (3.5% Y/Y)
	Chicago PMI	45.4
Friday	ISM Manufacturing	47.6

Source: Tradingeconomics.com

Despite Friday being the first of December, payrolls are not released until next week due to the holiday last week. Plus, in addition to the data above, we hear from seven different Fed speakers over ten venues including Chairman Powell Friday morning. That will be the last Fed speaker until the next FOMC meeting, so it will be keenly watched. However, I would wager a great deal it will continue to harp on progress made but higher for longer to prevent any resurgence in inflation.

As to the dollar, right now, it is softening as market participants focus on the idea of Fed cuts and simultaneously reduce large, long USD positions. For now, I feel like lower is the way forward, but if we start to see increased hawkishness again because there is no landing, merely continued growth, look for the dollar to return to its winning ways.

Good luck

Adf

Singin’ the Blues

Posted on November 10, 2023 by fxpoet

Before Powell stepped to the mike
The buyers of bonds went on strike
Then Jay warned again
Inflation is when
Both prices and yields tend to spike

Investors absorbed this new news,
(The bond market fail and Jay’s cues)
And offloaded risk
In manner quite brisk
So, that’s why we’re singin’ the blues

Remember when I explained that some weeks are just really slow? Just kidding! The remarkable thing about financial markets is one most always be alert to a shift in sentiment, even if it doesn’t make that much sense. However, yesterday’s shift made sense.

Last week when the QRA was published, the market took the news that a much larger percentage of issuance in the coming two quarters would be T-bills and not notes or bonds as a huge positive. We saw a significant rally in the bond market with 10-year Treasury yields falling nearly 50bps and we saw a corresponding rally in the equity markets as the major indices rose nearly 5%. Everybody was happy and the narrative was the worst was over for the risk asset correction. Oops!

This week has been the Treasury auction week, when they issue the newest tranches of 3yr, 10yr and 30yr notes and bonds. On Tuesday, the 3yr went fine. On Wednesday, the 10yr was acceptable, if a little weak, but given the broader narrative of positivity, it had limited impact. Alas, yesterday, the 30yr was an unmitigated disaster.

The two key statistics that are followed in this relatively arcane part of the markets are the tail (the difference between the final yield and the lowest bid accepted) and the bid-to-cover (BTC) ratio which describes the total amount of bids compared to the issue on offer. Typical tails are in the 0.5bp – 1.5bp range. Yesterday saw a 5.3bp tail, the largest ever, with the implication that they had to go through many bids to fill in the auction. The BTC yesterday was 2.24, far below the 2.38 average of the past ten auctions, and another indication that investors are not that interested in owning long duration Treasury paper. In fact, dealers (mostly banks) had to absorb almost 40% of the issue, double the usual amount. This is another indication that there aren’t many natural buyers of this paper right now.

In the wake of this auction, we saw bond yields rise sharply, up 11bps from the open, through the auction and then afterwards until the time that Chairman Powell spoke. Now, while Powell didn’t actually throw more gasoline on this fire, he certainly stoked it. Speaking at an IMF conference, he opened his comments with the following (emphasis added), “The Federal Open Market Committee (FOMC) is committed to achieving a stance of monetary policy that is sufficiently restrictive to bring inflation down to 2 percent over time; we are not confident that we have achieved such a stance.” A bit later he made sure to remind us, “If it becomes appropriate to tighten policy further, we will not hesitate to do so. We will keep at it until the job is done.”

Needless to say, risk assets did not perform well yesterday or overnight (US indices fell between -0.65% and -0.95%, Asian indices fell as much as -1.75% and European bourses are all lower by about -1.0% this morning) as investors dreams of rainbows and unicorns came crashing into the reality of the idea that interest rates are not going to be declining anytime soon. Not only is it unlikely that the Fed is going to reverse course, but yesterday was the first concrete indication that the cost of funding the US budget deficit may be starting to become a problem. (In fairness, it has been a problem all year and pointed out as such by numerous pundits, but yesterday the market, as a whole, seemed to get the message.) This is a major crimp in the narrative that just got developed last week.

Recall, the view that had come out of the Fed’s allegedly dovish stance and the weaker than expected NFP report was the Fed was done, inflation was going to fall, and yields would be heading lower across the curve. The unspoken part of that narrative was that there would be plenty of demand for Treasury paper because both investors and traders would be jumping in to get ahead of the decline in yields. Apparently, this feature of the narrative will need to be restructured, and with it, potentially, the entire narrative. This process is going to be the major market driver over the coming months and quarters. If the Fed maintains its higher for longer stance, and more importantly, continues along the QT path, shrinking its balance sheet, they will achieve the reduction in demand they currently seek to bring things into balance. Unfortunately, given the Fed’s inability to fine-tune this process, things have the chance to get very messy on the downside.

Summing up, the bullish narrative took a major hit yesterday and we will need to see a perfect combination of gently slowing economic data alongside quickly slowing inflation data to resurrect it. Personally, I would take the under on that bet. In fact, I fear that we could well see a much more rapid decline in economic data, with a recession on tap for early 2024 along with still sticky inflation keeping the Fed firmly wedged between that rock and that hard place. In this scenario, risk assets are very likely to underperform substantially. A key to watch will be the shape of the US yield curve. If (when) the bear steepening reasserts itself and long-term yields rise above the front end of the curve, you can be sure that a recession will be right around the corner. Sic semper erat, et sic semper erit. (Look it up)

Ok, well after that distressing discussion, a quick look at how other markets have behaved shows the following. Treasuries have edged lower by 2bps this morning, but that was after yesterday’s 14bp rally. European sovereigns, though, were closed when all the fun happened and so are catching up with yields higher by 6bps-7bps across the board. Not surprisingly, JGBs are little changed, but then there is no indication that the BOJ is going to stop QE anytime soon.

On the commodity front, oil (+1.5%) seems like it is finding a floor after its recent sharp decline, although given its inherent volatility (both literal and financial) I’m not confident the bottom is in. There has been much talk of significant speculative selling as a key driver of this move, but regardless of why, I would be wary of much signal from its price movement right now. Meanwhile, gold (-0.6%) which rallied sharply yesterday is in the process of giving it all back and base metals remain under general pressure.

Finally, the dollar is mixed this morning with both gainers and losers across the G10 and EMG blocs. In truth, the G10 movement has been quite limited, +/- 0.2% or less with one exception, NOK (+0.8%) which is benefitting from higher-than-expected CPI data and the belief that Norgesbank is going to be tighter going forward. In the EMG bloc, the movements have been a bit larger, 0.3% – 0.5%, but we are also seeing a mix of directions with, for example, MXN weaker while PLN is stronger. Net, I would say there is not much new here (the dollar did rally yesterday in the wake of the higher US yields) and I expect that traders will be happy to go home square this weekend.

On the data front, this morning brings the Michigan Consumer Sentiment (exp 63.7) and, remarkably, even more Fed speakers with Logan and Bostic on the calendar. At this point in time, I suspect that both traders and investors are going to be re-evaluating their medium- and long-term views on the progression of both economic activity and inflation. The bullishness of last week’s narrative has clearly been called into question. Arguably, we are going to need to see a lot more data to help convince market participants of the next trend. Next Tuesday starts with CPI data where a hot print will likely be seen quite negatively as it will push any Fed ease further into the future. But today does not seem like a session where much more will happen. In the end, as long as the Fed remains the most hawkish, and after yesterday I think that was reinforced, the dollar should find support.

Good luck and good weekend

Adf

Damp Squib

Posted on November 9, 2023 by fxpoet

While everyone waited for Jay
To blind us with brilliant wordplay
Seems he only said
The quants at the Fed
Try hard and their work is okay

This damp squib forced traders to seek
An alternate reason to tweak
Positions and views
But there’s just no news
At least not the rest of the week

The tedium continues another day. There have always been periods in the markets when there is very little of note ongoing and so pundits work hard to pump one story or another in order to generate enthusiasm, and on Wall Street, more trading activity. But sometimes, like right now, one is better off paying attention to something else more important (for instance, college football). With that in mind, this morning’s note will be brief.

There was a great deal of anticipation ahead of Chairman Powell’s comments yesterday morning, but he gave no satisfaction by simply lauding the folks who work at the Fed’s Research and Statistics group. That is the group that prepares the official Fed forecasts, and he was quite complementary of their effort. The fact that they are often completely wrong is incidental. Perhaps the most interesting thing he said was an oblique suggestion that they consider different models of the economy at times as things do change over time. I heartily agree with that sentiment, but sincerely doubt that PhD economists who have made their entire reputation based on their pet models are going to change anything given it might imply their previous efforts fell short. The upshot of the Powell speech was it had no impact on anything.

As to the rest of the Fed speakers, they simply repeated that inflation is still too high and that they will continue to do whatever they think is necessary to push it lower. There was some caution about having gone too far from Chicago Fed President Goolsbee, but even he explained that it will take time before they can be certain they have achieved their goal.

Away from Fedspeak, there was no US data and this morning’s discussion has centered on Chinese CPI data which showed the M/M reading fell to -0.1% while the Y/Y reading fell to -0.2%. Now, these are headline numbers, not core, and the fact that energy prices have been declining for the past month is likely a big part of this movement. But the outcome has tongues wagging about the coming deflationary wave that will soon hit the world. Don’t believe it. If ever there was a good time to use the term transitory regarding inflation, this seems to be it. Chinese deflation is transitory.

And that was literally the most impactful piece of data we have seen in the past 24 hours, if not the past 3 days. One other thing to note was that Ueda-san spoke at a conference in London and explained, “When we normalize short-term interest rates, we will have to be careful about what will happen to financial institutions, what will happen to borrowers of money in general and what will happen to aggregate demand. It is going to be a serious challenge for us.” I think he is absolutely correct; it will be very difficult to change that policy without a few things breaking. Good luck Ueda-san!

So, how have markets responded to this virtual lack of information? Pretty much as you might expect, with minimal movement. After a very quiet session in the US yesterday, where the major indices all closed withing 0.1% of Tuesday’s closes, Asia saw gains in Japan with the Nikkei higher by 1.5%, but Chinese shares did not respond well to the CPI data, sliding a bit. Europe, this morning is modestly firmer, on the order of 0.4% as the many ECB speakers are unable to convince investors that they will remain hawkish going forward, while US futures are still within 0.1% of Tuesday’s closes, i.e., unchanged.

Bond yields continue to be the driving force in markets and after a small decline in 10-year yields yesterday, they have bounced 3bps this morning. We have seen similar moves throughout Europe, 2bp – 3bp rises which seem to simply be following the Treasury market. Meanwhile, JGB yields have edged lower by 2bps overnight, although it will be interesting to see how the local market responds to the Ueda comments above when they open tomorrow. I would expect that we are still a long way from 1.00%. One other thing to note is that the 2yr-10yr curve inversion is growing still larger, with this morning’s level up to -42bps. This tells me that there is still a great deal of volatility to come in the bond market, and by extension across all financial markets.

Oil prices, which have been getting decimated lately, have settled for the moment and are higher by 0.5%, but now hovering around $75/bbl. It is abundantly clear that the market is far more concerned with the demand destruction story than the supply constraint story. This seems at odds with the soft-landing / no-landing crowd that is continuing to drive the equity markets, although I suspect the commodity folks have it right. Metals markets, both precious and base, also remain under pressure on the weak economic story being driven by high real yields.

Finally, the dollar continues to range trade with the most noteworthy movement being USDJPY pushing toward new highs for the move above 151.00. Until such time as the BOJ really changes policy, and based on Ueda-san’s comments, I think that is still some ways off, it is hard to get excited about owning the yen. As to the rest of the market, the EMG bloc is suffering more than the G10 bloc, and if I had to describe a direction, I would say the dollar is modestly firmer overall.

We finally have some data this morning, with Initial (exp 218K) and Continuing (1820K) Claims hitting the tape at 8:30. We have a bunch more Fed speakers, including Chairman Powell again at 3:00 this afternoon. We shall see if he veers closer to monetary policy today than yesterday’s nothing burger. And one last thing, Banxico meets today and is expected to leave their base rate unchanged at 11.25%.

It is difficult to get excited about this market and it beggars’ belief that Powell is going to change his tune given the lack of new information. As such, look for another quiet session across the board. The next shoe to drop is CPI, but that is not until next Tuesday. Til then, there is little reason to expect any significant movement in either direction.

Good luck

Adf

The Bond, or Not the Bond

Posted on November 8, 2023 by fxpoet

The bond, or not the bond, that is the question:
Whether ‘tis nobler for the Fed to consider
That long-term yields have offered outrageous fortune,
Or to take Arms against a Sea of inflation
And in opposing it: hike rates yet again

(with deepest apologies to William Shakespeare)

For some reason, the ongoing cacophony of Fedspeak regarding whether the rise in long-term yields is helping the Fed in their efforts, or whether it is merely incidental, brought this famous soliloquy to mind. We have had no less than eight different Fed speakers from the time Dallas Fed president Logan first mentioned the idea several weeks ago through yesterday discuss the subject with the majority continuing to latch on to the benefits for the Fed, although some dismiss the issue. Now, in any definition of financial conditions I have ever seen, long-term yields are part of the construction, so it is perfectly reasonable to take them into account. Clearly, the Fed is aware of this as QE was created entirely to ease financial conditions and consisted of simply buying bonds to lower long-term yields. However, now that the Fed is in QT mode, their ability to control the long end of the curve has vanished. In fact, if anything it is simply pushing those yields higher by removing themselves, a price-insensitive buyer, from the mix.

The problem for Chairman Powell is that whatever the Fed’s reaction function is with respect to data, the market’s reaction function to any hint that the Fed has finished tightening policy is well understood by one and all; BUY STONKS!! The reason I believe this is a concern for Powell and co. is that they fear a rally in equities will signal an all-clear on the inflation front. And it is abundantly clear that there is nobody on the FOMC who is prepared to claim victory over inflation. That is exclusively the stance of the CNBC bulls and the administration sycophants who are paid to make that case specifically. Reality, however, continues to demonstrate that inflation remains a feature of our everyday lives and I suspect that the FOMC mostly understands that. Remember, too, that the Fed is data dependent, or so they say, which implies that they are not in a position to anticipate the death of inflation, rather they will only accept that premise when they see the body.

Where does this leave us now? I suspect that the ongoing dance between the Fed and the markets with respect to the future of inflation will continue to play out for at least another year. In fact, nothing has changed my view that inflation will remain well above their 2.0% target for the foreseeable future, likely finding a new home in the 3.5% +/- range. And as long as Powell is Fed Chair, I see no indication he is willing to reverse course. While the Fed may not hike rates again, certainly the market does not believe that is going to be the case with just a 9.6% probability of a hike in December now priced, I find it extremely difficult to believe they will cut rates anytime soon absent clear signs that we are already in a recession.

Though soft-landing bulls have all scoffed
The fact that the data was soft
In China implies
It cannot surprise
If growth worldwide can’t stay aloft

So, is a recession coming soon to an economy near you? That is the $64 trillion question and one where there are myriad views expressed daily. The most recent inkling that economic activity is slowing more sharply than had previously been thought was the surprisingly weak Chinese trade data, where not only did their trade surplus decline substantially (to a still robust $56.5B) but exports fell in absolute terms, they did not merely rise more slowly than imports. The implication is that global growth is slowing more rapidly than the narrative explains.

We already know that Europe is in a world of trouble with Germany the current sick man of the continent, but we also have seen the latest Atlanta Fed GDPNow data showing that growth in the US is slowing as well with the latest reading at 1.2%. The UK is struggling as are many Asian nations, notably South Korea and Taiwan, or at least their export industries which are the key economic drivers there.

Another clue is the recent sharp decline in the price of oil, which has fallen -5.0% this week and ~-10% in the past month. Clearly, a part of this price decline is based on the growing belief (hope?) that the Israeli-Palestinian conflict will not spread into a wider Middle East conflagration that affects oil production. But part of this is the fact that oil inventories are building as are gasoline and diesel inventories with the result that prices are falling sharply. Given it wasn’t that long ago when there were shortages in these products, it appears that demand is falling sharply as well. Remember, diesel fuel is what drives the world as essentially no industry or commerce could continue without its use. The fact that less is being used is a clear signal of slowing activity.

Putting it all together shows that amidst what appears to be a slowing global growth impulse, markets are pricing out further central bank monetary policy tightening. Equity markets have been looking at the second part of that equation, less tightening and potential easing, while ignoring the first part, slower growth leading to lower profits. It is very easy, at least for me, to accept the idea that markets have not yet understood that slower economic activity will lead to lower profits and subsequently, lower equity prices. Alas, I understand that sequence so remain quite cautious overall.

Ok, how has this translated overnight? Well, after a modest rally in the US yesterday, equity markets in Asia were a bit softer, declining on the order of -0.35% while European bourses are edging slightly higher this morning, maybe +0.1%. US futures at this hour (7:45) are basically unchanged as we all await Chairman Powell’s dulcet tones at 10:15 this morning.

Bond yields are also quiet this morning with Treasuries (+2bps) one of the larger movers as European sovereigns are almost all unchanged right now. It seems that the market has found a new temporary home around the 4.60% level and the yield curve inversion continues to deepen, now at -36bps. JGB yields, which have fallen from their recent YCC-tweak induced highs, have edged up overnight by 3bps, but are at 0.85%, still far from the 1.00% target or cap or concept, whatever they are calling it now.

We already know that oil is under pressure, having fallen sharply yesterday and another -1.2% this morning. In fact, at $76.35/bbl, it is trading at its lowest level since mid-July. Gold, too, has been suffering, down -0.3% this morning and drifting further away from the $2000/oz level as those Middle East fears seem to dissipate. Copper and aluminum are also under pressure on the slowing growth story worldwide. Foodstuffs, however, are generally bid lately, as we can all discern every time we go grocery shopping.

Finally, the dollar is back to its dominant ways again, rallying vs. almost all its counterparts in both the G10 and EMG blocs. USDJPY is marching back toward 151 this morning, the euro is back below 1.07 and the pound back below 1.23. Meanwhile, in the EMG space, ZAR (-1.1%) is the laggard although it has competition from CLP (-0.9%), KRW (-0.7%) and HUF (-0.7%) as virtually the entire bloc is under pressure. In fact, CNY (-0.15%) is about the best performer as the PBOC continues to prevent any significant further declines.

Aside from Powell’s speech this morning, we hear from Williams, Barr and Jefferson, but there is absolutely no data to be released. Given the dearth of new data on the calendar, this week is going to continue to be all about the Fedspeak. In fact, Powell speaks again tomorrow and there are 5 more speakers as well by Friday, so rather than data, this week is about parsing language. Of course, Powell will set the tone today, and I am confident he will continue to push back on the idea the Fed is done. But we shall see.

In the end, it still seems to me that a higher dollar is the path of least resistance. Manage accordingly.

Good luck

Adf

Bad News is Good

Posted on November 6, 2023 by fxpoet

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

Good luck

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No Longer a Threat

Posted on November 3, 2023 by fxpoet

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

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

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

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

Source: tradingeconomics.com

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

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

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

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

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

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

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

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

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

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

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

Good luck and good weekend

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fxpoetry

Explaining the rhyme and rhythm of the FX markets each day

Tag Archives: #Powell

Too Clever by Half

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No Longer a Threat