Tag Archives: #Powell

News Not to Like

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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

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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

Adf

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

Adf

Not Quite Yet Dead

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Inflation is not quite yet dead
And that has some thinking the Fed
May now have concern
That there’ll be no turn
And possibly more hikes instead

Last week, though, more Fedspeak, we heard
And three speakers’ comments sent word
That higher long rates
Have altered the fates
Now they think hikes could be deferred

Before I touch on the markets, I must acknowledge the heinous acts that occurred last weekend in Israel.  It is abundantly clear that this will not be ending soon, and it seems likely that it may ultimately have an impact on financial markets.  However, this commentary revolves around how global markets move, what new catalysts are driving things and how we might consider all the information when trying to determine the best way to hedge outstanding FX exposures.

So, before we talk about the overnight session, let’s quickly recap my week away.  Inflation, in both the guise of PPI and CPI, was a bit hotter than expected which has put a crimp in the Paul Krugman ‘inflation battle is won’ narrative.  I am constantly amazed at the disingenuity of analysts explaining that if you ignore food, energy, rent, used cars and any other thing that rose, then inflation is back at the Fed’s target.  It is not clear to me if they don’t eat, use energy, or pay for living expenses, but that is simply ridiculous.  The consumer confidence data makes clear that folks are extremely unhappy with the current economic situation and too high inflation remains the primary cause.  Regardless of the data points, people are feeling it when they buy gas and groceries, or if they go out for dinner, let alone buying other stuff.  

I have maintained this is not going to end soon and that 3.5% – 4.0% is going to be the new normal inflation rate.  While Daly, Logan and Jefferson all explained that the steepening of the yield curve with long end rates rising more rapidly than short end rates was helping the Fed’s cause, not one of them indicated they were even thinking about thinking about cutting rates.  In fact, my money is on at least one more hike, probably in December at this point, and I cannot rule out further hikes in 2024.  And folks, higher rates are going to wind up breaking more things.  Do not believe the soft-landing narrative, things are going to get worse, almost certainly.  Arguably, that sums up last week.

Turning to the overnight session, there was limited new news in the way of data or commentary.  Market participants continue to focus on central banks and any potential adjustments in their policies, economic data and clues as to whether the long-anticipated recession is finally coming, and the trajectory of inflation and whether the price of oil is going to have a longer-term impact on that trajectory.

Regarding the first of these issues, in addition to the above-mentioned Fedspeak, the market is anxiously awaiting Chairman Powell’s comments to be made Thursday afternoon just before the Fed’s quiet period begins.  While we will hear from ten other Fed speakers over sixteen different venues (!), the reality is that Powell’s words are the most important.  However, given the seeming unanimity in the new message about the long end of the curve helping the Fed, I suspect that Powell will touch on that subject as well.  To my mind, this is not an indication they are unhappy with the bond market selloff, rather that they are quite comfortable and will not do anything to stop it.  That could well give the bond market vigilantes a signal to sell even more aggressively so be prepared.

Last night we did hear from Kanda-san of the MOF who explained that rate hikes are one option when excessive forex moves are seen.  Now, that seems a bit of a surprise in that the BOJ is ostensibly the one controlling interest rates, but this shows that the concept of central bank independence is quite tenuous in Japan, and probably in most places.  You may recall a few weeks ago when USDJPY touched 150 and immediately reversed and fell 2% in mysterious fashion as no intervention was confirmed.  Do not be surprised if we see similar price action at various levels higher in the dollar, although helpfully, there was a comment that the fundamentals (meaning interest rate differentials) were responsible for much of the movement in FX.  Nothing has changed my view that USDJPY has higher to go.

On the economic data front, obviously last week’s inflation data had an impact with Treasury yields shaking off their safe-haven bid due to the Israeli-Palastinian conflict and rising again this morning.  While they are not yet back at the highest levels seen two weeks ago, I expect we will get back there and move higher still going forward.  This week’s Retail Sales data (exp 0.3%, 0.2% ex autos) is the big print and recall, it has been running hotter than expected for a while now.  Understand that Retail Sales counts the dollars spent, not the items bought, so rising inflation will drive this number higher even if things aren’t improving.  But for now, there is scant evidence that the economy is slowing rapidly, at least based on the headline data we have been seeing for the past months.

Finally, the inflation story is part and parcel of all the discussions.  Oil’s rise on the back of the Israeli-Palestinian conflict has been pronounced and this morning it remains some 7% higher than before things started there.  There is a growing concern that if the conflict widens, OPEC could consider an embargo of some sort, just like in 1973 in the wake of the Yom Kippur War, which would likely drive oil prices much higher, at least to $150/bbl.  Obviously, that would have a dramatic impact on financial markets as well as on our everyday lives.  It would also have a dramatic impact on inflationary readings.  But the other concern is that despite some of the more Pollyanna-ish narratives about the Fed has already achieved its goals, the reality appears to be that core inflation is simply not falling any further and ultimately, this is going to weigh on equity multiples and earnings as well as further on bond prices.  I would contend that inflation remains the primary issue for the foreseeable future.

With all this in mind, a quick look at the overnight session shows that after a mixed session in the US on Friday, Asian equity markets were all lower by at least -1.0%.  European bourses, however, have managed to eke out very modest gains, on the order of 0.2% and US futures are currently (7:30) higher by about 0.25%.

Meanwhile, Treasury yields are higher by 9bps this morning and we are seeing yields on European sovereigns all higher by between 4bps and 5bps.  Clearly inflation concerns are rampant, as are concerns over continuing increases in supply as every major nation runs a growing budget deficit.  Of course, the exception to this rule is Japan, where yields are unchanged on the day and currently sitting at 0.75%, their high point for the past decade, although still well below the current YCC cap of 1.00%.

Turning to commodities, with oil quiet this morning focus is turning to the metals markets where gold (-0.8%) is retracing some of last week’s 5.0% rally as the combination of rising inflation and fear seems to have underpinned the barbarous relic.  As to base metals, they are mixed this morning with copper a touch higher and aluminum a touch lower, a perfect metaphor for the confusion on the economic situation.

Finally, the dollar is clearly not dead yet.  While this morning it is consolidating last week’s gains and has edged lower about 0.15%, last week saw gains in excess of 1% vs. most major counterparts.  The dollar, despite all the problems in the US, continues to be the haven of choice for most investors.

On the data front, aside from Retail Sales and the remarkable amount of Fedspeak, we see the following:

TodayEmpire Manufacturing-7
TuesdayRetail Sales0.3%
 -ex autos0.2%
 IP0.0%
 Capacity Utilization79.6%
WednesdayHousing Starts1.38M
 Building Permits1.455M
ThursdayInitial Claims213K
 Continuing Claims1707K
 Philly Fed11.1
 Existing Home Sales3.89M

Source: TradingEconomics.com

For my money, barring something surprising from the Middle East, like an OPEC move, I expect that the market will be entirely focused on Powell’s speech Thursday at noon.  We are also at the beginning of earnings season, so we could get some surprises there.  However, the big picture remains sticky inflation, massive new supply of Treasuries and higher yields along with a higher dollar overall.

Good luck

Adf

Waters, Uncharted

Posted on by 
Last quarter, chair Jay set the stage
For yields to go on a rampage
Now, Q4 has started
And, waters, uncharted
Seem dead ahead in this new age

Both oil and dollars are rising
And bond yields worldwide keep surprising
By rising as well
With efforts to quell
Those hikes what CB’s are devising

As we begin the fourth quarter it appears the trends that had been quite clear for most of Q3, rising oil prices, rising bond yields and a stronger dollar, all remain intact. Historically, when this condition has prevailed, it has been a negative, and frequently a very large negative, for risk assets.  This begs the question, is something going to change or is it different this time?  Now, we all know that it is ‘never’ different this time, the cycles of financial markets have repeated constantly throughout history with pretty clear causes and effects.  In the current circumstance, the combination of these three indicators rising simultaneously is going to reduce the ability of non-USD economies to access necessary commodities as their prices are rising even more in local terms than in dollar terms, and the rise in interest rates is forcing them to pay more interest on their outstanding debt.  And every developing country has lots of outstanding debt, so this is a universal issue.

If we work under the assumption that this time is NOT different, then the question is, what is going to change and when might that occur?  This goes back to the idea that the Fed will raise rates until something breaks.  As of now, while a few things have broken (UK insurance companies, some regional US banks, Credit Suisse) it appears the economy continues to perform at a higher level than virtually everybody had anticipated it could.  As of yet, the most highly anticipated recession in history has still not occurred.  In fact, the soft-landing narrative, where the Fed manages to reduce inflation without pushing the economy into recession, has become the consensus view (alas this poet disagrees with that view and fears a much deeper recession is coming our way.)

So, what might change?  Well, last night the BOJ indicated that they are going to be performing an extra round of JGB buying in Q4 as they are growing increasingly concerned about the rise in JGB yields.  Last night, 10yr JGB’s moved up to 0.76%, after touching 0.775%, the highest level in more than a decade.  So, more QE is a clear possibility.  Now, we all know that the Fed is continuing its QT process, having reduced its balance sheet by a shade under $1 trillion so far and claiming they will continue to allow bonds to roll off without replacing them for quite a while yet.  The ECB is also engaged in this process and the BOE actually increased its target, now planning to sell £100 of gilts in 2024, up from the previous amount of £80 billion.  Will the central banks be able to continue these policies if the economy does tip into recession?  I think not, but they have maintained that the balance sheet issue is separate from their policy framework.

A direct impact of the QT programs is that bond yields are rising because of the absence of demand from what had been price insensitive buyers (aka central banks) which forces the private sector to absorb all the new issuance and they are requiring higher yields to take the paper.  Given the extraordinarily high levels of debt that exist, both on government and private balance sheets, it certainly seems like we might soon reach a breaking point here.  However, until that point is reached forcing a reversal in central bank views regarding their balance sheets, I anticipate yields will continue to rise.

The direct corollary to rising yields, especially rising Treasury yields as they are leading the way, is that the dollar is following along for the ride.  If you are looking for the dollar to reverse course, you are, almost by definition, looking for the Fed to reverse course.  Yet, there is no indication that is the case.  In fact, the only central bank that has demonstrated they are willing to end the tightening cycle is the BOJ, and let’s face it, they haven’t really started a tightening cycle, the market is simply anticipating that one is coming soon.

Oil, meanwhile, remains exogenous to the central bank story and is an OPEC story.  The poohbahs there meet this week in Vienna but there is no expectation of a change in their current production policy.  This means that the supply of oil is unlikely to rise anytime soon while demand, given the more robust than expected economic activity, continues apace.  Nothing has changed this story that a decade of misguided ESG policies has created a structural supply deficit of oil and the price is destined to continue to rise going forward.

Alas, the upshot of this set of conditions as we enter Q4 remains risk assets are likely to remain under pressure until whatever that something is finally breaks and the central banking community, notably the Fed, changes their tune.  Keep your ears peeled for that change in tune.

Now to today’s markets, where equity markets in Asia that were open, notably Japan, were a bit softer while China is on their Golden Week holiday so markets are basically closed all week.  That said, we did see their PMI data released on Friday night and Saturday and it was slightly stronger than expected, and for the first time since March, all the readings were above 50.0, albeit just barely.  Nonetheless, a positive sign.  As to Europe, weakness across the board is the description of the day, with the major bourses lower by between -0.3% and-0.6%.  US futures, which had been barely positive earlier in the evening session, are now slightly softer as well, -0.3% or so at 8:30.

Bond yields are rising again with Treasuries higher by 6bps and back above 4.60% while the bear steepening continues with the 2yr-10yr spread now “just” -47bps.  As well, throughout Europe we are seeing sovereign yields rise about 3bp-4bp across the board as this trend of still high inflation, rising oil prices and ongoing QT is working its ‘magic’.

Speaking of oil, it is back on the rise with WTI up 0.5% and above $91/bbl this morning as we have seen consistent drawdowns in inventory for the past several months as the OPEC supply cuts have really started to bite.  One thing that we need to keep an eye on going forward is NatGas, which as we come into winter and the colder weather, could well see a lot of upward pressure, especially in Europe.  Looking at the metals markets, the combination of rising prices in oil, yields and the dollar is really starting to weigh on this sector with gold down another -0.75% and getting closer to $1800/0z, down more than 5% in the past month.  Copper (-1.6%) and aluminum (-0.3%) are also under pressure today and both are feeling the weight of developing downtrends.

Finally, the dollar, which sold off slightly on Friday into month-end, has reversed course and is stronger across the board this morning with the DXY up 0.35% while some outliers are ZAR (-1.1%) and MXN (-0.7%), both suffering from the strong dollar disease.

On the data front, the PMI data from Europe was still awful, with Germany still sub 40.0 and the Eurozone at 43.4.  As to the rest of the week, we get important things culminating in Fridays NFP report.

TodayISM Manufacturing47.7
 Construction Spending0.5%
TuesdayJOLTS Job Openings8.83M
WednesdayADP Employment160K
 ISM Services53.6
 Factory Orders0.3%
ThursdayInitial Claims210K
 Continuing Claims1678K
 Trade Balance-$64.6B
FridayNonFarm Payrolls163K
 Private Payrolls160K
 Manufacturing Payrolls5K
 Unemployment Rate3.7%
 Average Hourly Earnings0.3% (4.3% Y/Y)
 Average Weekly Hours34.4
 Participation Rate62.9%
 Consumer Credit$12.5B

Source: Tradingeconomics.com

As well as all this, we hear from nine different Fed speakers across eleven events including Chairman Powell this morning at 11:00am.  And that is just what is on the schedule, I expect we will hear some BBG interviews or things like that as well.  

The question remains, is something going to change, either because of the data or the tone of Fed speeches?  There is no indication the Fed is changing their attitude and I expect that will remain the case until the data changes.  I have maintained for more than a year that the NFP report is critical to Powell and friends as it is their CYA document.  As long as the Unemployment rate remains lower than 4.2% or so, and NFP is positive, nothing will deter them on their mission against inflation.  And that means the dollar will remain underpinned.

Good luck

Adf

Feel More Pain

Posted on by 
The data continues to show
That growth seems increasingly slow
But Fed speakers say
That rates need to stay
Still higher for longer, you know

Meanwhile market stress has increased
With both stock and bond love deceased
Can this trend maintain
As folks feel more pain?
Or will Jay soon let the bulls feast?

Yesterday’s US data was pretty lousy with the key pieces, New Home Sales (675K vs. exp 700K) and Consumer Confidence (103 vs. exp 105.5) both missing pretty badly.  The news overnight was also worse than forecast with Japanese Leading Indicators falling alongside German GfK Consumer Confidence and French Employment.  In other words, weakening data is not a US-only phenomenon.  Yesterday’s equity market performance was certainly in sync with the downward view with markets selling off around the world.  All in all, bad news seems to be everywhere.

The interesting thing this morning is how many pundits are bottom fishing, at least rhetorically.  I have seen numerous comments on the idea that as the data continues to fade and markets come under pressure that is the signal that the central banks are going to be forced to pivot and cut rates soon.  Part and parcel of that argument is the slowing economic activity is going to not merely slow inflation but cause a deflationary crisis!  I guess if you are going to make the case, you need to be as hyperbolic as possible to get those clicks.

From this poet’s view, which incorporates far too many years of observation, I think it is quite premature to believe that the downward trend in risk assets is going to change anytime soon.  Remember this, Chairman Powell has repeatedly said that he expects there would need to be some economic pain in order for the Fed to achieve their goal of 2% core PCE inflation.  And he was not talking about market pain, he was referring to rising unemployment and slowing economic activity.  However, it seems that similar to the situation when he told us all that he would be raising rates to fight inflation regardless of the market’s response back at the beginning of this process in March 2022, and everybody (including this poet) doubted his conviction, he has been very clear that he is willing to accept some pain to achieve their goals.  I do not doubt him at this stage based on his actions to date and I think it would be a mistake for others to do so.  

The one thing that we know about the history of inflation is it is never transitory.  While past policy responses have resulted in either limited impact and a strong upward trajectory, or short-term impacts with increasing waves of inflation over time, there has never been a case where inflation rose, rates were raised, and things got better.  At least not once it hit 5%.  Powell has made it very clear that he is going to do everything he can to be the first to kill inflation with one shot, but that means the shot is going to be long and difficult to withstand.  FWIW, which may not be that much, the answer to my final question above is no, there is no rate cut on the horizon and that slower activity as well as rising unemployment are going to be a feature of the economy for at least another year.  I am sure that the Biden administration will be quite unhappy, but my sense is Powell is not really a Biden fan anyway (although interestingly he is a raging Dead Head!)

So, based on my thesis that higher for longer really means what it says, and that we are nowhere near longer yet, the fact that today has seen a very modest reprieve in risk assets is simply a function of a trading bounce, not a fundamental shift in views.  Let’s take a look.

Asian markets were broadly higher, but only just, with gains on the order of 0.1% – 0.25%, not nearly enough to offset recent weakness.  In Europe, most markets are actually a touch softer, not even able to bounce, but the losses are of similar magnitude, -0.1%.to -0.3%.  In fact, US futures, at this hour (7:30) are the best performing markets and they are only higher by 0.25% or so.  This has all the earmarks of a dead cat bounce.

In the bond market, yields have edged lower in the 10yr space by 2bp-3bp mostly, but remain very close to the recent 10 year plus highs.  It remains very difficult for me to look at the amount of issuance that is going to be necessary globally ($trillions) and combine that with the fact that central banks are no longer price insensitive buyers of bonds and come up with a scenario where yields can decline in the near term.  Add to this the ongoing inflation fears and the fact that curve inversions have allowed investors to buy short-term paper and gain better returns and I suspect that the clearing price for 10-year paper is going to be much higher yields, 5.5% or higher is not unreasonable.  

Now, understand that at some point, the pressure will become too great and central banks will reverse course, but I sense we are still early days in the process.  I do believe that the Fed, and all the major central banks will join the BOJ in their YCC activities at which point yields will fall sharply.  But we ain’t there yet!

In the commodity markets, oil (+2.0%) continues to rally and is back above $92/bbl this morning.  I know there is a great deal of belief that if we see slowing economic growth that will limit demand and prices will decline.  But the ongoing supply/demand mismatch is extreme and the fact that Russia has banned the export of diesel fuel, perhaps the most critical product that comes from a barrel of oil, has helped maintain an ongoing tightness in markets. 

One other thing to note is that the much-vaunted energy transition is showing the first signs of falling apart, or at least being subject to significant delays, as we have recently heard from the UK and Sweden that they would be delaying the ban on sales of ICE cars and gas boilers.  Remember, the transition is a key part of the lower oil price thesis.  It turns out that politicians have found that the reality of reducing energy consumption or transitioning to a source that is insufficient for current societal needs is a lot tougher when people feel the pain of the process.  Last year, in the wake of the Covid pandemic policies of infinite fiscal spending, there was limited concern about subsidizing the use of energy but this year as the budget numbers look uglier and uglier, that tune is changing.  I maintain it will be a very, very, very long time before fossil fuels are eliminated.  In fact, I suspect the dollar will be replaced before fossil fuels are, and you know I don’t foresee that for decades, at least.

As to the metals markets, both base and precious are lower this morning as higher yields, slowing economic activity and a strong dollar help undermine their short-term value.

Speaking of the dollar, rumors of its demise seem to have been greatly exaggerated as well.  Once again, this morning, it is higher with the euro (-0.3%) edging closer to 1.05 and the yen (-0.1%) solidly above 149.  USDCNY is pushing to 7.32 despite the PBOC’s continued efforts to drive it lower via the daily fix, and despite the fact that local banks were seen selling dollars aggressively onshore, apparently at the PBOC’s behest.  The only currency outperforming is NOK (+0.3%) which given oil’s rally makes perfect sense.  The same situation obtains in the emerging market blocs with most currencies weaker and a few simply treading water.  The dollar has rallied for the last 11 consecutive weeks, which is a pretty long streak in the broad scheme of things, so a pullback one week wouldn’t be a shock.  But right now, this does not seem like the week it is going to happen.

On the data front, today brings Durable Goods (exp -0.5%, 0.1% ex Transports) and then the EIA oil data later this morning.  There are no scheduled Fed speakers, so today’s price action is likely to continue based on risk appetite.  I still don’t see risk appetite as improving in the short term which implies lower stock and bond prices and the dollar maintaining its strength.

Good luck

Adf

Bright or Bleak

Posted on by 
As we look ahead to this week
Til Thursday, when Jay’s set to speak
There’s little of note
That’s like to promote
A change in one’s views, bright or bleak

Then Friday, we’ll get PCE
When traders are waiting to see
If there’s any chance
The Fed’s hawkish stance
May change and they’ll restart QE

Some days there is less happening than others, and today is one of those days.  There has been very limited data released with the German Ifo the most notable statistic and it showed virtually no change from last month, still quite negative on the German economy.  Given that Germany is in a recession, I guess that shouldn’t be a big surprise, but the depth of the gloom has only been surpassed by the Covid situation and the GFC.  Even the Eurozone bond crisis in 2012 never saw this indicator so weak.  However, beyond that, there is really very little to discuss.

Thus, let us focus on how things may look going forward.  There continues to be an underlying negative perception across most macroeconomic indicators with the US economy the last bastion of any sort of strength.  China remains in the doldrums with the property sector still under huge pressure and the government there not yet willing to truly bail it out.  Germany is leading Europe lower with other nations beginning to see accelerating weakness as evidenced by last week’s flash PMI data, and emerging markets are beholden to global growth as they do not yet have the ability to drive things on their own.  If the situation in the US is one of a slide into recession, then I expect that the EMG nations will find themselves under further pressure.

And what, you may ask, is driving this process?  Clearly it is the G10 central bank mantra of higher for longer as inflation continues to run rampant around the world.  This results in a situation where investors and hedgers need to determine how much longer the Fed and its brethren central banks will be able to hold the line.  The problem here is this is a political question, not an economic one and political answers are extremely difficult to forecast.

Given that there is a presidential election in the US in 2024 and that the UK will be going to the polls as well with PM Sunak’s stint in office on the line, I expect that there will be significant pressure from both those governments to have the central banks back off the policy tightening and support economic activity.  However, it is unclear when that pressure will really increase and how long either Powell or Bailey will be able to hold the current line.  One of the biggest problems for the Biden administration is that a Republican House of Representative seems unlikely to pass significant stimulus to help the president when recession arrives.  This can be seen in the current fight over the completion of the funding bills for next fiscal year and the potential for a government shutdown at the end of the month.  As such, for Biden, he will be entirely reliant on monetary stimulus which, right now, doesn’t seem forthcoming.

The UK situation will be different, as the Tories control Parliament, however, they are extremely unpopular right now, and it is not clear what they can do to change that situation.  Certainly, if the BOE were to ease policy, it might be a positive but remember, inflation in the UK is the highest in the developed world and so driving inflation higher will not be seen as a positive at all.  My understanding is inflation remains the major pub talking point throughout the UK.  And not in a good way!

In the end we are going to need to see some policy changes to change market behaviors and right now, that seems a fairly distant prospect.  For all of us holding risk assets, that may lead to an uncomfortable time as we have seen over the past week or two and as we see continuing this morning.  Unfortunately, the prospects for a reversal seem as gloomy as this morning’s NY weather.

Anyway, let’s turn to the markets and take stock.  The Nikkei (+0.85%) was the outlier overnight as it managed to rally while the rest of Asia, notably Chinese and Hong Kong shares, all fell pretty sharply.  As to Europe, it is all red there with most bourses pushing lower by about -1.0%.  It seems there is no reprieve yet.  US futures at this hour (8:00) are also under pressure after a lousy week last week, with all three major indices lower by about -0.3%.

However, don’t look for any support in the bond market with yields higher virtually across the board.  Treasury yields are now north of 4.50% and show no sign of slowing down while the 2yr note is not rising in sync.  The curve inversion is down to -60bps now, as the bear steepening continues.  But yields are higher across Europe as well as concerns over inflation continue to grow.  The only exception here is Japan, where JGB yields have edged down 1bp.

In the commodity space, it should be no surprise that the base metals are softer this morning given the economic gloom. As to oil, it was higher for most of the overnight session although it has slipped back to unchanged as New York gets going.  One interesting story is that Eastern Russian crude is now trading above Brent prices near $100/bbl, far, far above the G7 price cap of $60/bbl that was imposed last year.  I guess the G7 didn’t have the market power implicit with that ridiculous idea.

Finally, the dollar is firmer this morning against most of its counterpart currencies.  In the G10 the one outlier is SEK (+0.9%) which has rallied on the idea that the Riksbank has further to tighten than previously expected.  But otherwise, USDJPY is pushing toward 149 and clearly getting close to an uncomfortable level for the BOJ/MOF.  In the EMG space, the story is similar, with the dollar broadly higher across the board.  This has all the appearances of a straight dollar story on the back of rising yields.

On the data front, as mentioned earlier, there is not much on the docket:

TodayChicago Fed Nat’l Activity0.15
TuesdayCase Shiller Home Prices-1.0%
 New Home Sales700K
 Consumer Confidence105.6
WednesdayDurable Goods-0.4%
 -ex Transport0.2%
ThursdayInitial Claims217K
 Continuing Claims1675K
 Q2 GDP Final2.2%
FridayPersonal Spending0.5%
 Personal Income0.4%
 Core PCE0.2% (3.9% y/Y)
 Chicago PMI47.4
 Michigan Sentiment67.7

Source: Tradingeconomics.com

As well as the data, we hear from five Fed speakers beyond Chairman Powell, but clearly all eyes will be on him Thursday afternoon.  It is very difficult to look at the sweep of data and feel confident that the economy is going to avoid a recession.  However, as long as we continue to see strength in the payroll data, I think the Fed has the cover to maintain higher for longer.  Next week’s NFP is going to be crucial with the early estimates at 145K, still positive but sliding down from the past several years.  In the meantime, especially as yields continue to climb in the US, the dollar should remain underpinned against all its counterparts.

Good luck

Adf

Concerns Are Severe

Posted on by 
One look at the dot plot makes clear
Inflation concerns are severe
So, higher for longer
Is growing still stronger
And Jay implied few cuts next year

First, let’s recap the FOMC meeting.  The term hawkish pause had been used prior to the meeting as an expectation, and I guess that was a pretty apt description.  While they left policy on hold, as expected, the change in the dot plots, as seen below, indicate that even the doves on the Fed see fewer rate cuts next year, with just two now priced in from four priced in June.

Source: Fedreserve.gov

A quick reading shows that a majority of members expect one more hike this year, and now the median expectation for the end of 2024 has moved up to 5.125%, so 50bps lower than the median expectation for the end of 2023 and 50bps higher than the June plot.  To me, what is truly fascinating is the dispersion of expectations in 2025 and 2026, where there are clearly many opinions.  And finally, the longer run expectation has risen to 2.5% with many more members thinking it should be even higher than that.  The so-called neutral rate estimations seem to be creeping higher.  If you think about it, that makes some sense.  After all, given the ongoing forecasts for continued labor market tightness due to demographic concerns, and add in the massive budget deficits leading to significantly higher Treasury debt issuance, there is going to be pressure on rates to find a higher level.

The market response was quite negative, albeit not immediately, only after Powell started speaking.  But in the end, equity markets fell across the board in the US, with the NASDAQ taking the news the hardest, down -1.5%, as its similarity to long duration bonds was made evident.  Asian markets all fell overnight as well, with most tumbling more than -1.0% and European bourses are all under similar pressure, down -1.0% or so as well.  The one exception in Europe is Switzerland, where the SNB surprised the market and left rates on hold resulting in a weaker CHF and a very modest gain in their equity market.

However, the bigger market response was arguably in bonds, where yields rose to new highs for the move with the 2yr at 5.15% and the 10yr at 4.43%.  Once again, I point to the significant increase in debt that will be forthcoming from the US Treasury as they need to fund those budget deficits.  I have been making the case that a bear steepener would be the more likely outcome for the US yield curve.  That is where long-term rates rise more quickly than short-term rates due to the US fiscal policy and shrinking demand for US debt by key players, notably the Fed, but also China and Japan.  Nothing has changed that view.

Then early this morning, up north
Both Sweden and Norway brought forth
A quarter point hike
To act as a dike
Preventing price rises henceforth

After the Fed’s hawkish pause, we turn our attention to Europe, where the early movers, Sweden and Norway, both hiked twenty-five basis points, as expected, while both hinted that further hikes are not out of the question.  Inflation remains higher than target in both nations and in both cases, the currency has been relatively weak overall.  Switzerland left rates on hold, pointing to the fact that for the past three months, inflation has been within their target range, and they are beginning to see downward pressure on economic activity which they believe will keep that trend intact.

And lastly, from London we’ve learned
Another rate hike has been spurned
Though voting was tight
They said they’re alright
With waiting to see if things turned

As to the bigger story, the UK, expectations were split on a hike after yesterday’s tamer than expected CPI report while the pound fell ahead of the news.  And the change in expectations was appropriate as in a 5-4 vote, the BOE opted to remain on hold for the first time in two years.  They see that inflation may be easing more rapidly than previously expected, and they are concerned about overtightening.  While I have a hard time understanding how a 5.15% Base rate is tight compared to CPI running at 6.7% and core at 6.2%, I am clearly not a central banker.  At any rate, the pound fell further on the news and is now at its lowest level since March, while the FTSE 100 rallied back and is close to flat on the day from down nearly -1.0% before the announcement.  Gilt yields, however, are moving higher as the bond market there doesn’t seem to believe that the BOE is serious about fighting inflation.

And really, those are today’s key stories.  Late yesterday, Banco Central do Brazil cut the SELIC rate by 0.50%, as expected, and at the same time the BOE announced, the Central Bank of Turkey raised their refinancing rate by 5 full percentage points, to 30.0%, exactly as expected.  And to think, we get concerned over rates at 5%!

As to the rest of the day, there is a bunch of US data as follows: Philly Fed (exp -0.7), Initial claims (225K), Continuing Claims (1695K), Existing Home Sales (4.1M) and Leading Indicators (-0.5%).  As is typical, there are no Fed speakers scheduled the day after the FOMC meeting, but we will start to hear from them again tomorrow.

Putting it all together tells me that the Fed is not nearly ready to back off their current stance and will need to see substantial weakness in economic activity before changing their mind.  Meanwhile, last week’s ECB meeting and this morning’s BOE meeting tell me that the pain of higher interest rates in Europe is becoming palpable and the central banks are leaning more toward inflation as an outcome despite their mandates.  This continues to bode well for the dollar as the US remains the place with the highest available returns in the G10.

Tonight, we hear from the BOJ, where no change is expected.  I would contend, though, that the risk is there is some level of hawkishness that comes from that meeting as being more dovish seems an impossibility.  As such, there is a risk that the yen could see some short-term strength.  Keep that in mind as you look for your hedging levels.  

Good luck

Adf

If Doves Seduced

Posted on by 
The British inflation release
Showed prices did not quite increase
As much as expected
Though still they’re projected
To stay at a level, obese

But truly, all eyes have now turned
To Jay, when past two, we’ll have learned
If hawks rule the roost
Or if doves seduced
The Chairman with more rate hikes spurned

As New York walks into the office this morning, all thoughts are on how the FOMC meeting will play out.  The current expectation is for no rate movement today and still about a 50% chance of one more hike either in November or December.  More remarkably, as I wrote yesterday, is the belief that there will be 100 basis points of cuts next year despite the growing belief of either a soft landing or no landing.  Again, I ask, why would the Fed cut rates if the economy continues to grow with the current monetary policy?  However, at this point, all we can do is wait.

FWIW, which may not be much, I continue to see the outcome as follows; no movement today, 25bps in November and then a reassessment in December based on how the data continues to flow.  Nothing Powell has said indicates that he is comfortable that the Fed has vanquished inflation, and similar to the idea that every politician only cares about one thing, his reelection, I believe Powell is completely focused on just one thing, killing inflation.  He has made it abundantly clear in the past that he expected some economic pain would be necessary in order to achieve that outcome, and he is not going to be deterred at this stage.  It would not surprise me if Fed funds remained at the year-end 2023 rate, whether that is 5.50% of 5.75%, for all of 2024.  In fact, absent a very significant recession, that is what I believe will occur.  One man’s view.

Anyway, turning to the only other data of note today, UK CPI surprisingly fell to 6.7%, down from last month’s 6.8% reading and forecasts for a 7.0% outcome today based on rising energy and food prices.  Even better for Governor Bailey, the core rate fell to 6.2%, well below last month’s level of 6.9% and forecasts of 6.8%.  The pound dipped on the news, but only by -0.2%, as the entire FX complex remains in thrall to the FOMC outcome later this afternoon.  However, this inflation result has pundits asking whether Governor Bailey will be able to skip tomorrow’s rate hike, just like the Fed, and wait until November if they deem it still necessary.  My view here is that will not be the case.  Given the overall weakness in the UK economy, Bailey is clearly running out of room to hike rates, and tomorrow is likely to be his last chance to raise rates before the evidence of sustained weakness becomes clear.  Just like the rest of Europe, I expect the BOE will hike tomorrow and be done.

Once again, I will point out that the basis of my dollar views remains that the US is going to be the most hawkish of all the major economies, maintaining tighter monetary policy far longer than other nations, and that the dollar will naturally see investment flows continue.  After all, the combination of higher yields and potentially better growth prospects will be far too much for international investors to ignore.

For now, though, we wait for 2:00pm and the FOMC statement along with their new Summary of Economic Projections, and then for Chairman Powell’s presser at 2:30.  As such, until then I expect a pretty dull day.

Overnight, Asian equity markets were under pressure with losses in both Japanese and Chinese shares, as well as generally throughout the region.  The only noteworthy news was that the PBOC left rates on hold, which was widely expected, although there were those who thought they might cut again to support the weakening Chinese economy.  European bourses, though, are having a much better day, with all markets higher by at least 0.5% and several southern European nations seeing gains greater than 1%.  Meanwhile, at this hour (7:30), US futures are edging higher by 0.2% or so after modest declines yesterday.

In the bond market, yesterday’s closing level for 10yr Treasuries was the highest, at 4.36%, since October 2007, and although the yield is lower today by about 2bps, this trend remains intact.  The big mover today, though, is UK Gilts which have seen yields drop 8bps after that CPI report.  This has helped drag European sovereign yields lower by about 2bps as traders want to believe that the rate hikes are over everywhere in Europe, and cuts are the next step.  While that’s not my view, it is gaining traction.

In the commodity markets, oil (-1.0%) has finally had a pullback of substance after a rumor yesterday that the Biden administration was going to completely empty the SPR.  There has been no source for that story and no corroboration but given the move that oil has seen over the past 3 months, up more than 35%, a pullback is no surprise.  While there is likely to be a further short-term retreat here, the long-term prospects for oil remain significantly positive in my view.  As to the metals markets, industrials are a bit firmer this morning, perhaps on the idea that the rate hiking cycle in Europe is ending, while gold is unchanged.

Finally, the dollar is a bit softer this morning, but not very much.  The euro remains either side of 1.07 while USDJPY is pushing the 148 level, very close to the key 150 point where many participants believe the BOJ will step back into the market.  As to CNY, its home has been the 7.30 level despite all the effort that the PBOC has expended to strengthen the yuan.  The biggest winners today have been the Antipodeans, with both AUD and NZD firmer by 0.5% after the Minutes of the RBA meeting indicated that they were considering another rate hike at the last meeting although decided to hold off.  The implication is another hike could be in the cards.

On the data front, really the FOMC meeting is today’s only activity of note, although we will see the EIA oil inventories as well.  Until the meeting ends, I expect very little to occur.  Once the announcement is out, and even more importantly, once Powell starts to speak, be prepared for more volatility.

Good luck

Adf

What He’s Sought

Posted on by 
On Monday, the market did naught
As traders were giving much thought
To how Jay explains
The work that remains
For him to achieve what he’s sought

And so, while no change is expected
In rates, look at what is projected
The June dot plot showed
The Fed’s preferred road
Was four cuts will soon be effected

Once again, the overnight activity remains fairly dull as traders and investors around the world await the results of tomorrow’s FOMC meeting.  At this point, it seems quite clear the Fed will remain on hold tomorrow leaving Fed funds in a 5.25%-5.50% range while continuing their QT program.  With this in mind, all the excitement will come from the new Summary of Economic Projections (SEP) which includes the dot plot.  The dot plot is the graphical representation of the FOMC members’ expectations for the path of Fed funds going forward.  Below is the most recent release from the June meeting (chart from Bloomberg).

The chart shows each of the FOMC members’ forecasts for where Fed funds will be at the end of 2023, 2024, 2025 and over the long term.  The green line shows the median forecast which in June indicated a belief there will be one more rate hike in 2023 and then four rate cuts in 2024 with another five cuts in 2025 before eventually seeing Fed funds move back to the perceived ‘neutral’ rate of 2.5%.

However, let us consider how some alternative scenarios might evolve.  For instance, I continue to wonder why the Fed will be cutting rates by 100bps in 2024 if they no longer forecast a recession in the US.  After all, if the economy continues to chug along with rates at 5.5%, what purpose would be served by cutting rates?  And if the economy does enter a recession next year, something which seems realistic, then the Fed will be cutting far more than 100bps.  It’s funny, if you look at the dispersion of expectations for 2024, there is one member who feels certain a recession is coming, with an expected rate of 3.625%, and another one who sees higher for longer as lasting the entire year.  At least those two members are making some sense.  However, the idea that the Fed will cut just because, without a more severe economic shock, seems quite unlikely.  After all, Chairman Powell has invoked the ghost of Paul Volcker numerous times and explained they will not be fooled by a temporary decline in inflation.  Rather, they are in this for the long haul and will win the battle.

There are those who would argue that the Fed will cut rates, regardless of the economic situation, because the US cannot afford to continue to pay interest at the current level on their >$32 trillion in debt.  As such, Powell will feel enormous pressure from the administration to reduce rates to help the government.  Now, that is the exact opposite of central bank independence, but certainly not an impossible outcome.  But absent that type of situation, it strikes me that we remain a very long way from the Fed achieving their target inflation rate of 2.0%.  At this point, the one thing Powell has made abundantly clear is that he will not stop until they achieve that goal.  

Another fly in the rate cutting ointment is the price of oil.  Again, this morning it is higher, +0.8%, and now above $92/bbl and seemingly approaching the magical $100/bbl level.  In the wake of the Russian invasion of Ukraine, the Biden administration released some 300 million barrels from the US’s Strategic Petroleum Reserve (SPR) which helped moderate price increases at the time.  However, the ability to repeat that exercise does not exist as currently, the SPR only holds about 350 million barrels and there are actual physical constraints regarding the integrity of the salt domes in which the SPR is kept.  If too much is released, the domes could cave in.  When considering this alongside the ongoing production cuts from OPEC+ as well as the administration’s effective war on domestic oil production, it is reasonable to conclude that oil prices have higher to climb.  Working our way back to the Fed, the problem is that high energy prices ultimately become embedded in all prices, as even services require energy to be accomplished.  This underlying cost pressure is going to prevent any significant decline in the rate of inflation and, in turn, support the Fed’s higher for longer narrative for even longer.

Wrapping up the discussion, I would contend that absent a sharp recession, the Fed is not going to be pressured into cutting the Fed funds rate anytime soon.  Instead, I expect that we will continue to see longer end rates rise slowly as the combination of massive new issuance of Treasury debt and lingering inflation will require higher yields to find buyers.  Currently, the two largest non-Fed holders of Treasury securities are China and Japan, and both of them have been slowly liquidating their portfolios as they need dollars to sell in the FX markets in order to support their own currencies.  When push comes to shove, I expect that we will see US rates retain their advantage over other G10 currencies and that it will continue for a while to come.  As such, I continue to expect the dollar to outperform, at least until something really breaks.  However, what that something is remains open to debate.

Turning to the overnight session, which was quite uninteresting as mentioned above, we saw mixed to weaker performance in Asian equities, with only the Hang Seng managing to eke out any gains at all, while European bourses are mixed with the major exchanges all within 0.2% of yesterday’s closing levels.  Yesterday’s US performance was as close to unchanged as it could get while being open, and this morning’s futures market is showing tiny gains (<0.1%) at this hour (8:00).

Bond markets are somewhat mixed on the day, with Treasury yields backing up 2bps, while UK gilt yields are lower by 4bps and everything else is in between.  Eurozone final CPI for August was released with the headline ticking down 0.1% to 5.2%, but core unchanged at 5.3%, with both, obviously, still well above the ECB target.  Madame Lagarde must be praying quite hard for inflation to fall further as she made it clear she does not want to raise rates again.  In the end, the Eurozone has myriad problems with sticky high prices and slowing growth, an unenviable position.

Aside from oil’s gains, gold has been performing relatively well lately, which given the dollar’s resilience and higher interest rates seems somewhat odd.  One possible explanation is that there continues to be significant demand in Asia, where, for example, the Shanghai Gold exchange price is currently some $30/oz higher than on the COMEX, and this spread has been growing.  We have heard much about the record amount of gold buying by central banks this year, and this seems of a piece with that outcome.  However, looking at industrial metals, both copper and aluminum are softer this morning as the prospects for Chinese growth diminish and with them so do prospects for demand for those metals.

Finally, the dollar is a bit softer this morning vs. most of its G10 counterparts with NOK (+0.75%) leading the way higher on the back of oil’s continuing rally.  In fact, the entire commodity bloc is at the top of the charts today.  However, in the EMG bloc, we are seeing more of a mixed picture with an equal number of gainers and laggards and none showing exuberance in either direction.

On the data front today, we see Housing Starts (exp 1439K) and Building Permits (1440K) as well as Canadian CPI (3.8% headline, 3.7% core), with both measures rising and keeping pressure on the BOC.  There are still no speakers, so my take is that things will be dull until tomorrow’s FOMC announcement at 2:00pm.

Good luck

Adf