Tag Archives: #Powell

Clearly the Rage

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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 1st 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.

TodayNew Home Sales723K
 Dallas Fed Manufacturing-17
TuesdayCase Shiller Home Prices4.0%
 Consumer Confidence101.0
WednesdayQ3 GDP5.0%
 Goods Trade Balance-$85.7B
ThursdayInitial Claims220K
 Continuing Claims1872K
 Personal Income0.2%
 Personal Spending0.2%
 Core PCE0.2% (3.5% Y/Y)
 Chicago PMI45.4
FridayISM Manufacturing47.6

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

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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

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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

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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 by 
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…

  1. 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.
  2. The idea that slowing growth is a positive for equity prices seems a bit skewed as slowing growth typically leads to weaker profits.
  3. 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:

  1. 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
  2. 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

Adf

No Longer a Threat

Posted on by 
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 Payrolls180K
Private Payrolls158K
Manufacturing Payrolls-10K
Unemployment Rate3.8%
Average Hourly Earnings0.3% (4.0% Y/Y)
Average Weekly Hours34.4
ISM Services53.0

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 23rd.  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

Adf

Bulls’ Fondest Dreams

Posted on by 
While everyone focused on Jay
The earlier news of the day
Showed Janet would not
The long bond, allot,
Too much, thus yields faded away

Combining that news with the Fed
And all of the things that Jay said
It certainly seems
The bulls’ fondest dreams
Are likely to still be ahead

While most of the headlines yesterday afternoon and this morning revolve around the FOMC meeting and, more importantly, Powell’s press conference, I would argue that as I discussed yesterday, the biggest story was the QRA early in the morning.  Historically, the Treasury has tried to keep T-Bill issuance between 15% and 20% of total Treasury issuance.  However, a look at the current mix shows that Secretary Yellen already has that ratio up to 22.6%.  One of the big questions was how that would play out going forward.

Recall, one of the narratives that has been invoked for the Treasury bond sell-off with corresponding rising yields, has been the supply story.  You know, the US is running massive budget deficits and needs to issue more debt to fund it, so there is a lot more supply coming.  A key assumption in this story was that the mix of debt, which already favored T-Bills, would not change much so the new debt would be forced into the back end of the curve.  Well, that’s not how things worked.  The QRA indicated that the Treasury was going to issue a lot more T-Bills, a total of $1.1 trillion over the next two quarters, raising the proportion of T-Bills to 23.2%, even further above the old ceiling.  Of course, the result is much less issuance in the 5yr and longer space, thus undercutting the excess supply argument.

The results cannot be surprising as even before Powell started speaking, 10-year yields had fallen 11bps although they continued to decline afterwards as well, finishing the day lower by 16bps or so.  All in all, an impressive bond rally.  But let’s consider for a moment a different consequence of yesterday’s announcements, the shape of the yield curve.  Prior to the QRA and the Fed, the yield curve, as measured by the 2yr-10yr spread had fallen from a low of -108bps to just -15bps and it seemed almost certain that it would normalize soon.  However, now that the QRA has shown there will be more issuance out to 2yrs and less beyond, the immediate impact is the curve is going to go back to inverting further, (it is already back to -22bps) at least until such time as the Fed actually does cut rates.  I have a feeling that we are going to hear a lot more about recession again even though Powell explicitly said the Fed was not expecting one.  In fact, Powell and the Fed may be the only people not expecting a recession at this point!

A quick look at the Fed funds futures market shows that for the December FOMC meeting, the market is currently pricing a 20% probability of a 25bp rate hike.  That is slightly lower than before the FOMC meeting yesterday, but within the margin of error.  However, at this point, the market has a 43% probability of a rate cut in May, with that probability growing as you head out further in time.  One of the things Powell reiterated yesterday is that the committee is not even discussing the idea of a rate cut.  Of course, he also said that they don’t believe a recession is coming so it is not surprising the market has a different rate view than the Fed.

In the end, I think this is a seminal shift in policy with the combination of Treasury and Fed actions indicative of a much easier policy stance going forward.  I have built my views based on the Fed maintaining its higher for longer stance and continuing to stress the system which remains massively leveraged.  However, if he is no longer going to follow that path, and I think we learned yesterday that the inflection point is here, then we need to rethink the future.  One consequence of this policy change, though, is that inflation, which I have maintained is going to remain far stickier than many anticipate, is going to become an even bigger problem down the road.  I just don’t know how far down the road that will be.  But for now, I think we are going to continue to see equities rebound into year end, bond yields fall, the dollar fall, and commodity prices rebound.  This is going to be a classic risk-on scenario through the end of the year in my view.

And despite, or perhaps because of, continued weaker data, that is what we are seeing in markets around the world.  Yesterday’s ISM Manufacturing data was quite soft at 46.7, and this morning the PMI data from the rest of the world was generally awful with all European readings between 40 and 45.  Yesterday’s ADP Employment data was soft, at 113K which just added fuel to the policy easing fire and though the JOLTS Job Openings data was still strong, the net perception is slower times are ahead, and with them, lower interest rates.

A look around markets shows that after yesterday’s US rally, with the NASDAQ leading the way higher by 1.6%, Asian shares rallied (Nikkei +1.1%, Hang Seng +0.75%) and we are seeing strength across the board in Europe with all major indices higher by at least 1.25%.  And don’t worry, US futures are pushing higher again, up about 0.5% at this hour (7:15).

It is, of course, no surprise that bond yields around the world are lower with European sovereigns declining by between 7bps and 12bps after both Australia and New Zealand saw yields tumble 16pbs and 25bps respectively.  Even JGB yields are softer by 3bps.  In fact, Dutch central bank president Klaas Knot, one of the most hawkish ECB members, is on the tape this morning with the following quote, “We should be a little patient and not raise rates too much.”  That may be the most dovish thing he has ever said.  The point here is that until such time as inflation really comes roaring back (and I fear that day will come), the direction of travel in interest rates is lower.

Oil prices, which remained under some pressure in the past week, have bounced 1.4% this morning with the movement seeming to be a response to the policy changes while gold (+0.3%) is also climbing, although a bit slower than I might have expected.  But we are seeing strength throughout the commodity complex on the lower rate story with copper (+0.5%) rallying despite the prospects of a recession.

Finally, the dollar is under pressure across the board with the DXY down -0.7% led by the euro (+0.6%), AUD (+0.7%) and NZD (+0.95%).  The yen (+0.4%) is a bit of a laggard today, though remains above the 150 level, but I suspect that we are going to see dollar weakness continue going forward.  Against EMG currencies, we are also looking at a weaker greenback with KRW (+1.0%) leading the way, but strength through APAC and EEMEA and MXN (+0.6%) firmer as the only representative of LATAM that is trading at this hour.  Yesterday Banco Central do Brazil cut their SELIC rate by 50bps to 12.25% as widely expected and BRL rallied 2% on the day.  Again, the theme is now a weaker dollar going forward.

To show how big a deal yesterday was, the BOE meets this morning, and nobody is even discussing it.  Expectations are for no policy change, although perhaps given the sudden dovishness breaking out worldwide, they will consider a cut!  We also see a bunch of US data as follows: Initial Claims (exp 210K), Continuing Claims (1800K), Nonfarm Productivity (4.1%), Unit Labor Costs (0.7%) and Factory Orders (2.4%).   There are no Fed speakers on the schedule today, but they get started again tomorrow.  Remember, tomorrow we also see NFP, so still some fireworks potentially.

For now, though, the new trend is risk on, dollar down.  

Good luck

Adf

News Not to Like

Posted on by 
Before we all hear from Chair Jay
This morning we’ll see QRA
The question is will
The bond market kill
The vibe all things are okay

While no one expects a rate hike
Of late, there’s been news not to like
Both housing and wages
Have moved up in stages
Though as yet, there’s not been a spike

We are definitely in a period where there is a huge amount of new information to digest on a daily basis, whether it is data or policy actions by central banks and finance ministries.  During times like this, we have historically seen slightly less liquidity in markets as the big market-makers reduce their activity to prevent major blowups.  Of course, the result is that we have periods that are quite punctuated by sharp moves on the back of the latest soundbite.

So, with that in mind, let’s look at today’s stories.  Starting last night, we saw JGB yields rise to yet another new high for the move, touching 0.98%, before the BOJ executed an unscheduled bond-buying exercise to push back a bit.  Ultimately, the 10-year JGB closed back at 0.94%, but despite the brave words from Ueda-san yesterday, it is clear there will be no collapse in the JGB market.  They simply will not allow anything like that to happen.  At the same time, USDJPY retraced about 0.3% of its recent decline, but continues to hold above 151 for now.  We did hear from Kanda-san, the new Mr Yen, that they were watching carefully, but given the rise in JGB yields has been matched by the rise in Treasury yields, it is hard to get too bullish, yet, on the yen.  

This is the first big assumption that has not played out as anticipated.  Prior to the BOJ meeting, the working assumption was that when they adjusted YCC the yen would start to rally sharply.  My view has always been that the yen won’t rally sharply until the Fed changes their tune, and that is not yet in the cards.  If the BOJ intervenes, it is probably a good opportunity to sell at those firmer yen levels as until policies change, a weaker yen remains the most likely outcome.

Turning to the US, at 8:30 this morning the Treasury is due to announce the makeup of the $776 billion of debt they will be borrowing this quarter.  The key issue is how much will be short-dated T-bills and how much will be pushed out the curve.  The higher the percentage of long-dated issuance, the more pressure we will see on the bond market going forward.  The 10-year yield is already back to 4.90% this morning, rising another 3bps, and we are seeing pressure throughout Europe as well with yields there up between 1bp and 3bps except for Italian BTPs which have seen yields rise 9bps this morning.  That has taken the Bund-BTP spread back to 200bps, the place where the ECB starts to get concerned.

But back to the US, where a second key narrative assumption has been that housing prices would be falling, thus reducing pressure on the inflation metrics over time.  Alas, that assumption, too, has been called into question after yesterday’s Case Shiller home price data showed a rise in home prices across the country, back toward the peak seen in June 2022.  While the number of transactions continues to decline, given the reduction in both supply and demand it seems that it is still a sellers’ market.  If housing prices don’t decline, then it seems even more unlikely that rents will decline and that means that inflation is going to remain much stickier than the Fed would like to see.  This does not accord well with the thesis that a slowing economy is going to help bring down housing demand followed by slowing inflation.  

As well, there was another data point yesterday, the Employment Cost Index, which rose a more than expected 1.1% Q/Q, and looking at the chart of its recent movement, shows little inclination that it is heading lower.  This is a key data point for the Fed as rising wages is something of which they are greatly afraid given the belief in its impact on prices.  While the White House may have celebrated the UAW’s ability to extract significant gains from the big three automakers, I’m guessing the Fed was a bit more circumspect on the effects those wage gains will have on overall wages in the economy and inflation accordingly.  

Adding all this up tells me that the ongoing belief that inflation is going to be declining steadily going forward, thus allowing the Fed to reduce the Fed funds rate and achieve the highly sought soft-landing is in for a rude awakening.  Rather, I remain quite concerned that monetary policy is going to remain much tighter for much longer than the market bulls believe.  And that means that I remain quite concerned equity multiples will derate lower along with equity markets overall.

Turning to the overnight price action, after a late rebound in the US taking all three major indices higher on the day, though just by 0.3% or so, we saw a big boost in Tokyo, with the Nikkei jumping 2.4%, as it seems there is joy in the idea that the BOJ may allow yields to rise further.  Either that or they were happy to see the BOJ buy bonds, I can’t tell which!  Europe, though, is a touch softer this morning with very marginal declines and US futures markets are looking to reverse yesterday’s gains, all -0.35% or so, at this hour (8:00).

Oil prices are higher this morning, up 1.8% as concerns about escalation in the Middle East seem to be growing after some comments about a wider war and further attacks by both Iranian and Hamas leaders.  Gold is little changed today but did suffer in yesterday’s month end activity although copper is firmer this morning in something of a surprise given the continuing weak PMI data we have been seeing.

Finally, the dollar continues to flex its muscles as the DXY is back just below 107 with both the euro and pound lower this morning by about -0.25%, and virtually all EEMEA currencies under pressure as well.  Other than the yen’s modest rebound, the dollar is higher vs. just about everything.

On the data front, in addition to the QRA and the FOMC later this afternoon, we see ISM Manufacturing (exp 49.0), Construction Spending (0.5%) and JOLTS Job Openings (9.25M).  Overnight we saw weaker PMI data from Japan (48.7) and China (Caixin 49.5), although for some reason, European PMI data is not released until tomorrow.

At this point, it is very much a wait and see session but as far as I can tell, the big picture has not yet changed.  Inflation remains stickier than the Fed wants, and the market seems to believe which leads me to believe we are going to see yields remain higher for quite a while yet.  I would estimate we will see 5.5% 10-year yields before we see 4.5% yields and if that is the direction of travel, equity markets are going to have a tough time while the dollar maintains its bid.

Good luck

Adf

Dim-Witted

Posted on by 
Said Jay, though we’re strongly committed
To make sure no ‘flation’s permitted
Quite frankly we’re lost
And ‘fraid of the cost
If we screw up cause we’re dim-witted

So, we’ll watch the data releases
And act if inflation increases
But if it should fall
Then it will forestall
More hiking lest we step in feces

As expected, the Powell comments were yesterday’s highlights as he once again explained that the goal of 2% inflation remains their primary effort.  Not surprisingly, given what we have heard from the onslaught of Fed speakers over the past two weeks, he made clear that there will be no rate hike at the November meeting, but December is still in play.  When asked about the rise in long-term yields, he did indicate it could be doing some of the Fed’s work for them, just like we heard earlier this week from Lorrie Logan and others.  Somewhat surprisingly, he mentioned the rising budget deficits, describing them as on an “unsustainable” path.  Now, we all know this is true, but Powell has been extremely careful not to discuss government funding throughout his tenure as Chair.  I suspect his next testimony to Congress could be a little spicier!

Of course, the other six speakers added exactly nothing to the conversation as they merely reiterated in their own words the same message.  Perhaps of more interest was that despite effective confirmation that there was no hike upcoming and that the bar for a December rate hike was quite high, bonds continued to sell off with the 10yr yield closing at 5.0% while stocks took it on the chin again.  Methinks there is more than a little concern starting to grow amongst asset managers that the concept of the Fed put may finally be gone.  

The other really interesting outcome yesterday was the fact that gold rallied another 1.3% despite the ongoing rise in interest rates.  As there was no new news out of the Middle East of any real note, one possible explanation is that investors are simply getting quite scared overall.  

One thing is quite certain and that is if the situation changes such that Powell and company become concerned that the economy is reversing course and they have, in fact, overtightened monetary policy, any reversal of the current message is likely to lead to some very big moves.  In that case I would expect a much weaker dollar, a huge rally in gold and other commodities, an initial rally in equities and, remarkably, not much movement in bonds.  I remain of the strong belief that the supply issue is the key bond market driver, so that will only increase in the event of an economic slowdown and that cannot help the bond market, even if the Fed starts to buy them again.  But that is all hypothetical.

Turning to the overnight session, while risk continues to be shed in Asia and Europe, we did see Japanese inflation data where the headline rate declined to 3.0% and the core to 2.8% although their super core reading is still at 4.2%.  Certainly, Ueda-san must be pleased that the numbers are beginning to edge a bit lower although they remain far above the 2% target.  Of course, the very fact that they are edging lower implies that any end to QQE is even further in the future.  Recall, Ueda-san has been clear that he does not believe 2% inflation is yet sustainable in the economy and is concerned it is going to slip back below that level in the medium term.  With that attitude, he has exactly zero incentive to end YCC or QQE and seems far more likely to continue with them.  

The implication of this outcome is that the yen seems likely to weaken further.  Currently, USDJPY is trading at 149.95 and although it hasn’t touched the 150 level since that first brush on October 3rd, it has been grinding ever so slowly back there again.  This price action has all the earmarks of stealth intervention, something that may be carried out by the three Japanese mega banks at the BOJ’s behest.  However, given the ongoing trajectory in US interest rates, it seems only a matter of time before we once again breech 150.  It will be quite interesting to see the MOF/BOJ reaction at that time, although I suspect they will, at the very least, “check rates.”  For hedgers, be careful here.

And really, that’s all we’ve got to talk about today.  As mentioned above, equity markets fell in Asia overnight, with losses on the order of -0.5% or so and European bourses are all down about -1.0% this morning heading into the US open.  As to US futures, at this hour (7:00) they are off about -0.4% as we head into an option expiration session.  Thus far, earnings season has not been sufficient to excite investors and fear seems to be the driver of note.

Turning to the bond market, while we have backed off from yesterday’s closing highs of 5.0% by 5bps, we remain at multi-year highs and there is no reason to believe that we have seen the top in yields.  In fact, this move appears to be driven by rising real yields, not inflation concerns.  While real yields have already risen substantially over the past 6 months, rising from ~1.0% to the current 2.45%, history has shown that real yields can easily rise to 4% or more in the right circumstances, and these may just be those circumstance.  Again, there is no evidence that Treasury yields have topped.  As to European sovereigns this morning, they are edging lower by about -1bp after a large rally yesterday as well.  US Treasury price action continues to be the global driver for now.

Oil prices (+1.5%) continue to trade higher as concerns over a widening of the Israeli-Palestinian conflict keep traders on edge.  Combine this with the weaker production numbers from the US and the drawdown in inventories and you have the ingredients for a further price rally.  News that a US Missile Cruiser in the Red Sea shot down several drones and missiles launched from Yemen cannot have helped sentiment.  Meanwhile, gold (+0.4%, +2.6% this week) continues to play the role of safe haven.  Either that or there is a lot of short-covering ongoing.  The price is approaching $2000/oz, one of those big round numbers on which markets tend to focus so I would look for a test there if nothing else.  However, base metals are softer this morning as the price action today is not economically related.

Finally, the dollar continues to tread water this morning with most of the major currencies within +/- 0.2% of yesterday’s closing levels while EMG currencies seem to be edging a bit lower, down on the order of -0.3%.  The renminbi is little changed this morning despite (because of?) the PBOC injecting CNY733 billions of fresh liquidity into the market/economy there overnight.  Again, just like the yen, the diametrically opposed monetary policy of China and the US should lead to further currency weakness here over time.  Now, the PBOC doesn’t like to see sharp movement and will continue to prevent a blowout move, but the spot rate is currently trading right at its 2% band vs. the CFETS fixing, so something has got to give soon.  In the end, the dollar trend remains intact, but I must admit I am surprised it is not a bit stronger given the underlying fear in the market.

On the data front, there are no statistics released and we hear from two more Fed speakers, Harker and Mester, to finish things off before the quiet period begins.  It seems hard to believe that anything they say will be seen as more important than Powell’s comments yesterday.  As such, looking at today’s market activity, while there will be tape-watching regarding the Middle East and any escalation in hostilities, I suspect the equity market will have the most influence on things.  At this point, further weakness seems the most likely outcome, especially as traders will be reluctant to be overly long risk heading into the weekend.  

Good luck and good weekend

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Five Percent

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The number one story today
Is that 10-year bond yields soon may
Trade to five percent
As bond bulls lament
Their theory’s no longer in play

As I write this morning at 6:45, 10-year Treasury yields are now trading at 4.95% having touched 4.98% a few hours ago.  This has become the biggest story of the day given the psychological impact of yields rising to that level and the fact 5.00% is such a big round number.  There is a lot of sentiment regarding round numbers in markets, so things like parity in EURUSD or $100/bbl in oil or even stock indices (e.g., S&P at 4000) take on a life of their own whether or not there is any fundamental driver of a particular situation.  But let’s face it, the market is all about psychology, so if people care, it matters. 

If (when) we trade through 5.00% will anything have changed?  Unlikely, but it is definitely today’s narrative.  It appears that the drivers are anticipation of yet more supply next week as well as continued confirmation that the Fed is going to maintain Fed funds at current levels for quite a while, even if there are no more rate hikes.  We also continue to hear stories of selling by major holders although I addressed that yesterday.  Certainly, part of the market zeitgeist is the idea that the continued strong US economic data are the seeds for ongoing inflation pressures leading to higher yields.  But in the end, the only thing of which we are sure is that demand for paper, despite the highest yields in more than sixteen years, is underwhelming.  At least relative to the supply of paper that is available and due to come soon.

For now, I expect that as yields continue to climb, we are going to see ongoing struggles in the equity market, dollar strength and commodity prices struggling.  Of course, gold continues to buck that trend as it is holding up extremely well in the face of higher yields. 

In the meantime, it is worth remembering the Fed stance, which clearly still matters.  

Said Waller, we’ll “wait, watch and see”
How things in the broad ‘conomy
Evolve before moving
And if they’re improving
More rate hikes will be the decree

Said Williams, the time’s not arrived
To alter the rates we’ve contrived
Though, progress we’ve made
We’re still quite afraid
That falling inflation’s short-lived

It is becoming abundantly clear from the comments by all the Fed speakers during the past two weeks that there will be no policy rate movement at the next meeting.  Of course, Chairman Powell has yet to offer his views, which are due today at noon.  However, it seems difficult to believe that this overwhelming agreement of a pause to, as Governor Waller put it, “wait, watch and see,” the evolution of the economy has not been approved by the Chairman.  Nonetheless, you can be sure that his words will be parsed especially carefully later today.

Of course, the data continues to show that the economy is not slowing down in any substantive fashion and the bond vigilantes are out in force.  After yesterday’s 8bp yield rally above 4.90%, this morning’s movement should be no surprise.  We also saw European sovereign yields explode higher yesterday with UK Gilts up 15bps and continental bonds up between 5bps and 10bps.  As I have been consistently writing, this move is nowhere near over.  One other thing that has not yet garnered much attention is that the Bund-BTP spread is now at 206bps after the Italian government just passed a financing bill that includes a 4.2% government deficit, well above the 3.0% EU limit and above the promises made when PM Meloni first entered office.  Concerns are growing that Italian finances may soon become a real problem, not just for Italy, but for Europe as a whole.

We should also discuss the JGB market where the 10-year yield is now at 0.85%, creeping ever closer to their new alleged line in the sand at 1.00%.  Recall, the BOJ is the only major central bank that is explicitly buying bonds and has promised to buy an unlimited amount to prevent yields from rising above that 1.00% level. In fact, 1.00% JGB yields is the only round number that has any true significance.

Ultimately, the current interest rate / yield story is the key driver across all markets.  In addition to the dramatic movement we have seen in bond markets, yesterday saw pronounced weakness in equity markets and strength in the dollar.  After falling more than -1.0% here, Asian markets fell even more sharply, between -1.5% and -2.0%.  European bourses are also under pressure this morning, but not quite to the same extent as they suffered somewhat yesterday in their afternoon sessions.  As to US futures, they are unchanged at this hour (7:15) awaiting Powell’s comments.

Oil prices (-1.25%) are backing off a bit from their recent rally after news that the administration has relaxed sanctions on Venezuela indicating that there will be a bit more supply available.  However, yesterday’s inventory data showed significant drawdowns and cannot be ignored as a fundamental driver which would imply higher prices going forward.  Gold, after another spike yesterday of more than 1% is creeping still higher this morning with the best explanation a growing concern over a much more uncertain future.  After all, if investors are losing their faith in Treasury bonds, and as evidenced by the ongoing selling pressure, that is one possible explanation, gold has always served as the ultimate safe haven.  As to the base metals, they are also firmer this morning, arguably on the back of still surprisingly strong US economic data.

Finally, the dollar is mixed this morning, with gains vs. the pound and the commodity bloc while the euro has managed to edge higher.  USDJPY remains stuck just below the 150 level as though someone is working very hard to prevent that level from trading again.  In fact, we have traded between 149.40 and 149.85 for the past week, an extremely tight range that looks quite artificial.  Do not be surprised if we finally breech the 150 level for a time and then see another bout of intervention by the MOF/BOJ driving it back down again.  Ultimately, though, if the BOJ maintains its current stance, the yen is going to trend weaker.  

A quick look at the EMG bloc shows that CNY is trading to its weakest point in more than a month as news that Country Garden, the erstwhile largest property developer in China, failed to make a coupon payment yesterday for the second time and is set to file for bankruptcy has raised concerns over the entire economic process there.  Elsewhere, IDR (-0.5%) fell during its session although I would expect some strength tonight as the central bank there surprised the market and raised their base rate by 25bps after the market closed.  In general, the EMG bloc has seen weakness across the board with the dollar ‘wrecking ball’ wreaking havoc for those companies and countries that need to service their USD debt.

On the data front we see Initial (exp 212K) and Continuing (1710K) Claims as well as the Philly Fed (-6.4) and then Existing Home Sales (3.89M).  In addition to Chairman Powell, we hear from six other Fed speakers, although with Powell speaking and the second in the lineup, I don’t imagine the other comments will matter much.  Remember, after tomorrow, the Fed enters its quiet period as well.

Looking at the totality of the situation, it would be shocking if Powell added anything new to the debate.  At this point, I expect that the bond market will remain the driver of everything.  I also expect that 10-year yields above 5.00% are coming soon to a screen near you and that the normalization of the yield curve will be completed before the end of the year.  Right now, the 2yr-10yr spread is down to -28bps and an eventual move to +50bps – +100bps would put us back in ‘normal’ territory.  In other words, 10-year yields could rise much further!  In that situation, I still like the dollar overall.  I will need to see something substantial change before the dollar’s bullish trend turns around.

Good luck

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