Tag Archives: #Powell

Baked in the Cake

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A quarter is baked in the cake
Ere next time, when Jay takes a break
At least that’s the view
Of so many who
Get paid for, such statements, to make

The question, of course, is why Jay
Would wait, lest inflation’s at bay
The narrative, though,
Is all-in that low
Inflation is now here to stay

Well, it’s Fed Day so all focus will be there until this afternoon at 2:00 when the Statement is released and then, probably more importantly, at 2:30 when Chairman Powell begins his press conference.  Under the guise of a picture is worth a thousand words, I believe the next two charts, both unadulterated from Bloomberg are very effective at describing the current market expectations.  The first is a tabular and graphic depiction of the Fed funds futures market over the next year, which shows that today’s hike is fully priced in, and then there is a just under 50% probability of a hike either September or November.  After that, though, the market is convinced that Fed funds are going to fall, with more than 100 basis points of decline priced in through 2024.

Now, compare that to the second chart, the Dot Plot from the June FOMC meeting:

In truth, the two curves look pretty similar with perhaps the biggest difference the Fed’s current belief that they will absolutely hike twice before the end of 2023 rather than simply a 50% probability of such.  So, can we just assume this is the way things are going to be?  After all, if markets and the Fed agree on the same outcome, it seems likely to be realized, no?

Alas, this is where the narrative is based on crystal balls, not on data.  Whether it is the punditry or the Fed (or the FX Poet), nobody knows how things are actually going to play out.  One of the things that seems to be a throwaway line by every Fed speaker but is actually the most important part of the commentary is that their views are based on, ‘if the economy evolves as we expect it to.’  The problem is that the history of Fed prognostications is awful. 

Obviously, the most recent glaring error was the ‘inflation is transitory’ narrative that they peddled for a year while inflation was rising sharply for many very clear reasons.  Why we should think that their modelling prowess has improved since then is beyond me.  I have often opined that the problem for the Fed is that every one of their models is broken since they don’t accurately reflect the economy, not even a little bit.  Add to that the underlying premise which is that inflation is naturally at 2% and will head back there on its own, something with exactly zero empirical or theoretical support, and you have a recipe for policy errors.  

The latest policy error was the transitory delay, but perhaps the bigger problem for the Fed is the potential for a relatively unprecedented set of economic variables with higher than target inflation combined with slow economic activity yet low unemployment (due to the shrinkage of the labor force.). I don’t think their playbook has a play to address that problem and I fear that the politics of the outcome will have a disproportionate impact on any policies they implement.  If there is one thing of which we can be sure, it is that political solutions to economic problems are the worst kind with the longest-term negative impacts.  

It is for this reason that Powell’s press conference is so widely anticipated as that is where we will learn any new information.  But until then, I expect that markets will remain relatively benign.

A quick tour of the overnight session shows that there was no follow through to Monday night’s Chinese equity performance with the main exchanges in China and Japan all modestly lower.  Europe, however, is having a much tougher time this morning with the CAC (-2.0%) leading the way lower as concerns seem to be growing over the ongoing central bank tightening policies continuing into a recession.  There was vanishingly little data and no commentary of note, but we have seen some weaker than expected earnings numbers out of the continent, a sign that not all is well.  As to US futures, they are essentially unchanged at this hour (8:00) as investors await this afternoon’s Fed meeting.  I would be remiss, though, not to point out that there were several worse than expected earnings numbers, notably from Microsoft, which is a chink in the armor of the idea of infinite growth for AI.

Meanwhile, bond markets are under pressure in Europe with yields higher across the board there, on the order of 2.5bps to 3.5bps.  This appears to be a move based on expectations of continuing higher interest rates from the ECB.  Treasury yields, though, are unchanged on the day, and at 3.88%, currently sit right in the middle of the trading range we have seen for 2023.  As to JGB yields, they slipped 2bps last night with limited concern that Ueda-san is going to rock the boat tomorrow night.

Oil prices (-1.0%) are a bit softer, but this looks like a trading correction after a strong run higher rather than a fundamentally based story.  Base metals are also softer this morning as the Chinese inspired euphoria seems to have dissipated quickly while gold (+0.4%) is creeping higher despite rising yields and a modestly firmer dollar.  It appears to me there is an underlying bid to the yellow metal that will not go away regardless of the macro situation.

Finally, the dollar is slightly firmer this morning as risk aversion seems to be supporting the greenback.  JPY (+0.35%) is the G10 outlier on the plus side with the commodity bloc under the most pressure (AUD -0.7%, NOK -0.7%, SEK -0.5%).  In the emerging markets, THB (+0.7%) has been the best performer after a surprisingly positive Trade Balance with a large negative one anticipated.  However, the rest of the EMG space is mixed with some very weak currencies (HUF -1.0%, ZAR -0.9%) and some other modestly strong ones (BRL +0.4%, MYR +0.3%).  The forint story continues to revolve around central bank activity, with concerns they will ease policy with inflation still high, while the rand is simply suffering from its commodity basis.  Meanwhile, the real jumped after Fitch upgraded the country’s debt rating BB (stable) from BB-.

Ahead of the FOMC decision, we see New Home Sales (exp 725K) but that will be a nonevent given the afternoon’s agenda.  It is a fool’s errand to try to anticipate exactly how Powell will respond to the questions he receives, or even exactly how they will phrase their current views.  As such, today is one to watch and wait, then evaluate afterwards.

Good luck

Adf

Jay Will Scrape By

Posted on by 
Today it’s about CPI
As Jay and his cadre still try
To push prices lower
Which might mean growth’s slower
But don’t worry, Jay will scrape by

This morning we see the last big data point before the Fed meets in two weeks’ time as CPI is to be released at 8:30am.  According to Bloomberg’s survey, the median expectation is for both headline and core monthly prints of 0.3% with the Y/Y numbers at 3.1% headline and 5.0% core as a result.  There are many who are excited about the prospect of a 2 handle on the headline number as a potential catalyst for the equity market to break out even higher. The idea seems to be that a reading that low will get the Fed to change their tune and not merely stop raising rates but start bringing rate cuts back on the table.  Wishful thinking in my view, but that’s what makes markets.

Even a cursory analysis of the commentary from the plethora of Fed speakers we have heard since the last meeting shows that there is very little willingness to end the current tightening program anytime soon.  Certainly, there is no indication that a cut is even remotely a consideration.  But equity bulls need a story to push their thesis, so there you have it.  The thing is that while this month is clearly going to show a substantial decline on a year over year basis due to the base effects (remember, June 2022 M/M CPI was +1.2%, the peak), next month has the opposite base effect with the July 2022 M/M reading at 0.0%.

As I’m sure all of you are very clearly aware, there is essentially no evidence in our day-to-day llives that indicates prices are declining across the board.  While gasoline prices have certainly fallen from their highs, they appear to have bottomed along with oil, and if you head out to a restaurant, especially one that you frequent, I’m sure you’ve seen the same steady rise in prices that I have.  Remember, too, that CPI measures the change in prices on a monthly or annual basis, not the level of prices.  Absent deflation, something that is incredibly unlikely in the current monetary and fiscal framework, prices are never going back to where they were prior to the pandemic.  I sincerely hope wages continue to rise for all our sakes.

In the end, I continue to look at the employment situation as the critical variable for the Fed as weakness there will be the only thing that deters them from continuing their current mission.  Powell clearly believes that the Silicon Valley Bank situation has been completely contained and that there will be no further concerns to distract them going forward.  Maybe that is correct, but I am wary of accepting the idea that the fastest rate hikes in the Fed’s history are consistent with minimal damage to the economy.  My suspicion is that there will be far more coming, it’s just that refinancings have not been necessary yet.  When companies on the margin need to pay 9% to refinance their 4% coupon, it will result in an even greater uptick in bankruptcies than we have already seen this year and according to Epiq Bankruptcy, a compiler of bankruptcy information, filings have jumped by 68% this year compared to last, with a total of 2,973 in the first six months of the year.  If the Fed continues to tighten, look for this number to rise further, and possibly faster.  

Ahead of the data, the bulls remain in charge of the market with yesterday’s rally having been followed throughout Europe this morning although last night’s Asia session was more mixed.  In fact, one of the best performing markets of the year, Japan, has seen something of a reversal in the past two weeks as the Nikkei has fallen almost 11% while the yen has rallied about 3.5%.  This is no coincidence as much of Japan’s corporate profitability continues to rely on exports and the yen’s recent strength (+0.5% today with the dollar back below 140 again) has clearly been a weight around that market’s neck.  Interestingly, despite the same mercantilist mindset in China, the relation between the Chinese stock market and the renminbi is far less tight.  As it happens, CNY (+0.2%) is a bit firmer this morning but is less than 1% from its bottom while the Chinese stock market continues to flounder, having fallen yet again last night and continuing its downtrend for the year.

Turning to the bond market, 10-year yields have slipped another 2.5bps this morning as for now it appears the market is rejecting that 4.0% level.  Of more interest is the fact that the 2yr yield has fallen faster with the curve inversion down to -90bps.  This is an indication that bond investors are entertaining the idea that inflation is slowing, and the Fed will back off.  Be careful if there is a high CPI print today as that will almost certainly see quite the reversal of this price action.  Regarding the rest of the world, European sovereigns are following Treasuries with yields generally slipping between 2bps and 3bps, but the real surprise is Japan, where yields rose 1.9bps last night and are now at 0.467%, quite close to the YCC cap for the first time in Ueda-san’s tenure.  The combination of rising JGB yields and a stronger yen has a lot of tongues wagging that a policy change is in the offing in Tokyo.  It strikes me that Ueda-san is far more likely to move when the market is not expecting something rather than being seen to respond to pressure from the market.  However, anything is possible there.

WTI is back above $75/bbl this morning for the first time in two months and there are many, this pundit included, who believe that we may have seen the bottom.  Fundamentals like the Saudi production cuts and the Biden administration discussion of refilling the SPR are adding support, as is the fact that while recession continues to be forecast, it has not yet seemed to arrive.  Do not be surprised if we see $80/bbl or higher before the summer is over.  As to metals prices, gold is marginally higher this morning, benefitting from the dollar’s continuing weakness, as are both copper and aluminum.

Finally, talking about the dollar’s weakness, it is widespread with NOK (+0.65%) rallying alongside oil and SEK (+0.5%) also benefitting from commodity prices.  The only G10 laggard is NZD (-0.2%) which seems to have been disappointed that the RBNZ left rates on hold last night.  Speaking of central banks, this morning we hear from the BOC which is expected to raise rates again by 25bps to 5.0% at 10:00am so be attuned for any alternative outcome.

As to the emerging markets, it is a story of modest strength across almost the entire set with no real outstanding stories to highlight.

In addition to CPI, we also get the Fed’s Beige Book this afternoon and we hear from four more Fed speakers starting with Richmond’s Thomas Barkin right when CPI is released.  The only thing that might be interesting is if somebody starts to change the tune, something that I find highly unlikely at this time.

We will have to see the print to have any chance of understanding the next steps, but for now, the dollar is on its heels and absent a strong print, seems likely to test its recent lows before anything else.

Good luck

Adf

Deflation’s Emerged

Posted on by 
Inflation in China is sliding
Which now has some pundits deciding
Elsewhere round the globe
The deeper you probe
DEFLATION’s emerged from its hiding

For equity bulls it’s a sign
That US rates soon will decline
But thus far Chair Jay
Keeps pounding away
That higher for longer is fine

By far the story that has gotten the most press from the overnight session has been the Chinese inflation readings.  For good order’s sake, they showed that the Y/Y CPI rate fell to 0.0%, down 2 ticks from last month and 2 ticks below expectations, while the Y/Y PPI rate fell to -5.4%, far below last month’s -4.6% reading and the lowest level since the end of 2015.

 

There have been numerous takes on the implications of this data.  In the short-term column, we have seen weakness in AUD (-0.7%) and NZD (-0.5%) as the narrative explains the falling inflation indicates falling demand and slowing growth in China, thus reducing the need for Antipodean exports.  Interestingly, this take does not effectively explain commodity price movements as although oil (-0.7%) is a bit lower this morning, both copper (+1.3%) and aluminum (+0.8%) are having quite a solid session.  Of course, the entire China reopening is bullish for the global economy and inflation story has been a disappointment from the get-go, so it is not clear why this is suddenly changing any opinions.

 

However, if you listen to the longer-term takes on this data, pundits are implying this is proof that the inflation genie is getting stuffed back into its lamp, and that soon, as inflation tumbles in the US, the Fed will finally pivot, and stock prices will run to new highs.  Quite frankly, I have a much harder time accepting the long-term take than the equity bulls seem to have.

 

A key part of this narrative is that come Wednesday, CPI in the US will be declining sharply to 3.1%, at least according to the current median Bloomberg estimate.  It is widely known this decline is due to the base effect as expectations are for a M/M outcome of 0.3%.  However, -ex food & energy, CPI is still forecast to print at 5.0%, well above the Fed’s target, and the number that Chairman Powell has been highly focused on of late.  It seems that the current narrative, at least in the equity world, is that China’s falling inflation will soon spread around the world and allow interest rates to head lower again thus supporting stock prices. 

 

The thing is, this is an equity market narrative, not a bond market one.  Turning to the bond market shows that yields remain quite firm with the 10-year still solidly above 4.00% (currently 4.05%, -1bp on the day), and the 2yr right near 5.0%.  Fed funds futures markets continue to price in a rate hike at the end of July with a 50% chance of another one by the November meeting, and no thoughts of a rate cut until June 2024.  In other words, while the equity cheerleaders are extrapolating from weak Chinese inflation to weak US (and global) inflation right away, the bond market continues to see the world quite differently.  This dichotomy in world view has been extant for many months now and eventually will be resolved.  The key question is, will the resolution be a sharp decline in bond yields?  Or a sharp decline in equity prices?  And that, of course, is the $64 billion question.

 

For what it’s worth, and it may not be much, I continue to lean toward an eventual equity market correction rather than a reversal of Fed policy and much lower US yields.  Well, I guess what I expect is that the air will come out of the equity bubble as the long-awaited recession finally arrives at which point the Fed will indeed feel cutting rates is appropriate.  However, there is just no indication this part of the cycle is imminent.  Remember, that on a long-term basis, equity multiples remain well above average and a reversion to the mean, at least, ought not be surprising.  As the earnings season for Q2 kicks off soon, there is ample opportunity for disappointment and the beginnings of a change of heart.  I couldn’t help but notice that Samsung, the largest chipmaker in the world, reported a 96% decline in profits in Q2 on Friday, hardly a sign of ongoing strength, AI be damned.  And while one company is not a trend, this one is certainly a tech bellwether and should not be ignored.

 

The point is that a correction in equity markets ought not be a huge surprise based on the ongoing, and rising, interest rate structure in the US, along with the very clear manufacturing recession in which the US, and most of the world, finds itself. 

 

Adding to this less optimistic view would be Friday’s NFP report which saw a weaker than expected headline print for the first time in more than a year, with significant revisions lower for the past two months.  The underlying metrics were not terrible, and on the inflation front, Average Hourly Earnings remain at 4.7%, well above the level the Fed believe is appropriate to allow them to achieve their 2% inflation target.  In other words, nothing about this report screams the Fed is done.  In fact, just the opposite, as those earnings numbers continue to pressure inflation higher.  Concluding, I believe it is premature to expect any Fed policy change and I am beginning to sense that we are observing the first cracks in the bull market thesis.  We shall see.

 

As to the rest of the market picture overnight, Friday’s US weakness was matched in Japan (-0.6%) and Australia, but Chinese shares rallied by a similar amount.  It seems there is growing belief that the Chinese government is going to offer more support for the economy there.  European bourses are in the green this morning, on the order of 0.5%, while US futures are essentially unchanged at this hour (8:00).  At this point, all eyes are on Wednesday’s CPI report so don’t be surprised if we have a couple of quiet sessions until then.

 

As to the rest of the bond market, European sovereigns have all sold off slightly with yields edging higher by between 1bp and 2bps although there has been no data of note released.  Perhaps more interesting is the fact that JGB yields are creeping higher, up 3bps overnight and now at 0.454%, much closer to the YCC cap of 0.50% than we have seen since April, immediately after Ueda-san took the helm.  There has been a lot of chatter about Japan doing something as they are ostensibly becoming uncomfortable with the yen’s ongoing weakness, so this is something to keep on the radar.

 

Speaking of the yen, while it is unchanged overnight, there has been no continuation from Friday’s sharp rally in the currency which was built on rumors of a BOJ policy adjustment or perhaps direct intervention.  But this is an area that must be watched closely as recall, last October, the BOJ was actively selling dollars to halt the yen’s slide then.  Elsewhere, though, the dollar is ever so slightly firmer on the day, with both gainers and losers in the EMG bloc, although none having moved very far.  Here, too, I feel like the market is awaiting the CPI data for its next catalyst.

 

A look at the data for this week shows the following:

 

Today

Consumer Credit

$20.0B

Tuesday

NFIB Small Biz Optimism

89.9

Wednesday

CPI

0.3% (3.1% Y/Y)

 

-ex food & energy

0.3% (5.0% Y/Y)

 

Fed’s Beige Book

 

Thursday

Initial Claims

250K

 

Continuing Claims

1720K

 

PPI

0.2% (0.4% Y/Y)

 

-ex food & energy

0.2% (2.6% Y/Y)

Friday

Michigan Sentiment

65.5

Source: Bloomberg

 

In addition to the CPI and PPI data, we hear from seven Fed speakers across nine events this week, with this morning being particularly busy as four different speakers will be on the tape between 10 and noon.  If you recall, there seemed to be the beginnings of dissent based on the Minutes we saw last week, so perhaps the message will get mixed, but as of now, I see no reason to believe that Powell will wait before hiking again.  In fact, the June 2022 M/M inflation print was the highest of the cycle at 1.2%, hence the base effect issue for this month.  Meanwhile, the July M/M reading will be compared to last July’s 0.0% reading, so I expect next month’s CPI will be much higher on Y/Y basis.  This will not be lost on Powell and the Fed. 

 

In the end, there has been nothing to change my view that the Fed is going to stay on course and that they will continue to drive the currency world overall with the dollar likely still the biggest beneficiary over time.

 

Good luck

Adf

Inflation’s Fate’s Sealed

Posted on by 
The Minutes revealed that the Fed
When pondering their views ahead
Are no longer all
Completely in thrall
With hiking til more ink is red

However, they also revealed
That some felt a still higher yield
Was proper for June
And want more hikes soon
To make sure inflation’s fate’s sealed

Yesterday’s FOMC Minutes were interesting for the fact that after more than a year of the committee remaining completely in sync, it appears we have finally reached the point where there is a more robust discussion of the next steps.  The hawkish pause skip was very clearly an uneasy compromise between those members who thought it was appropriate, after 10 consecutive rate hikes, to step back and see if things were actually playing out in the manner their models predicted and those that remained adamant it was inappropriate to delay their process as there has been far too little progress on the reduction in services inflation.  Remember, the Fed’s models are entirely Keynesian in that they assume higher interest rates reduce demand by forcing financing costs higher.  It is why Chairman Powell has repeatedly explained that in order to achieve their goals, a little pain is going to be required.

 

But consider the nature of the current bout of inflation.  Was this driven by excess money being created in the banking sector and spent on business investment, or even share buybacks?  Or was this inflation driven by excess money being created, and then handed directly to the public in order to help everyone during the government-imposed lockdowns, thus spent immediately on goods, and eventually on services once the lockdowns were lifted?

 

I would argue that the latter is a more accurate representation of the current situation, one more akin to the post WWII economy than the 1970’s oil embargo led economy.  If this is the situation, then perhaps continuing to raise interest rates may not be the best solution to the problem.  In fact, as Lynn Alden indicates in her most recent piece, it could well be counterproductive.  If this inflation is fiscally (meaning government led) driven rather than monetarily (meaning bank lending led) driven, higher interest rates simply add to the amount of money available to spend by the public.  In fact, this process becomes circular as higher interest rates increase the amount of interest paid to bondholders adding to their disposable incomes, while simultaneously increasing the size of the fiscal deficit, thus increasing debt issuance, and driving interest rates higher still.  This is an unenviable place for the Fed to find itself, especially since its models don’t really accept this premise.  Rather, they continue to fight the 1970’s inflation via the Volcker playbook, which may only exacerbate the situation.

 

My growing concern is that the Fed is fighting the wrong enemy, and in fact, has no tools to fight the excessive fiscal spending which is currently the key driver of demand.  As such, it is very realistic to expect inflation, whether measured as PCE or CPI, is going to remain elevated on a core basis for quite a while yet.  When combining this thesis with both deglobalization and incremental labor shortages, the case for higher inflation for longer becomes even more compelling.  We have already seen that the housing market has not behaved at all in the manner expected by the Fed’s (or anybody’s) models, with prices holding up far better than anticipated given the dramatic rise in interest rates over the past 18 months.  It is not hard to believe that other variables in the Fed’s models are equally wrong.  In the end, this is further confirmation, to me, that the Fed will be fighting its inflation battle for a very long time.

 

How have markets reacted to this new information?  Not terribly well with financial assets falling in value around the world.  This is true in equities, where yesterday’s modest US declines were followed by much sharper falls in Asia and Europe with the Hang Seng (-3.0%) the laggard but all of Europe down by more than -1.0% today.  US futures are also under pressure, down about -0.4% as I type (7:30).

 

But despite the fall in equity markets, bond prices are tumbling as well with yields rising around the world.  Treasury yields are actually the best performers, rising only 4bps this morning, although that has taken them tantalizingly close to the 4.00% level which has proven to be a more significant hurdle for equities in the recent past.  But in Europe and the UK, bond yields are screaming higher with Gilts (+10bps) leading the way, but all Continental sovereigns seeing yields rise by at least 6bps.  This is interesting given the fact that the only data released today was Construction PMI data which was incredibly weak across all of Europe and the UK.  Clearly, the prospect of higher Fed funds is one of the driving forces here as higher for longer gets more deeply embedded in the market belief set.

 

Speaking of higher Fed funds, the market is currently pricing an 85% probability of a hike later this month and then only a slight chance of a second one, despite the Fed’s comments.  In Europe, the situation is similar, with a 90% probability priced for July but only one more hike in total by the end of the year.  And remember, the ECB is 125bps behind the Fed in terms of the level of rates, and inflation remains higher in the Eurozone than in the US.  It feels like there will be more changes to come in these markets.

 

Oil prices, meanwhile, continue to be supported with the rationale being the Saudi’s continued production cuts.  While there is a story that Iran has been pumping more oil into the market, the price action has certainly been a bit more bullish lately.  Structurally, there is still going to be a shortage of oil over time, but for now, that doesn’t seem to matter.  Meanwhile, base metals are edging lower this morning, after the weak construction data, and gold remains stuck in its consolidation.

 

As to the dollar, it is generally, though not universally, lower this morning with the yen (+0.6%) the leading gainer on fading risk sentiment, although there is also a building story that Ueda-san is going to be making some adjustments in the near future in order to mitigate the recent weakness.  While it has been relatively slow and steady, as it approaches 145, it clearly seems to be generating some discomfort.  But in the G10, the weakness is broad.  However, in the EMG bloc, the dollar has had a much better showing rising against a majority of the group with ZAR (-0.9%) the laggard on the weaker metals’ prices, but weakness throughout APAC and LATAM currencies as well.  If we continue to see US rates climb higher, I expect that the dollar will be dragged along for the ride.

 

On the data front today, there is a lot of stuff, starting with ADP Employment (exp 225K) and followed by the Trade Balance (-$69.0B), Initial Claims (245K), Continuing Claims (1734K), JOLTS Job Openings (9885K) and finally ISM Services (51.2) at 10:00.  I saw a story that there has been a seasonal adjustment issue with the Claims data because of the Juneteenth holiday, which is quite new, and so not necessarily properly accounted for in the release.  Over time, these things will smooth out, but do not be surprised if today’s Claims print is higher than expected.  And of course, this all leads up to tomorrow’s NFP report, something I will discuss then.  Dallas’s Lori Logan speaks today, but she is not currently a voter.  Next week, however, we hear from a lot of Fed speakers, so perhaps some fireworks are on the horizon.

 

Overall, I think there is a case to be made that the Fed is looking in the wrong direction and that they will continue to raise the Fed funds rate and drive all yields higher without having the desired disinflationary impact.  In that scenario, I think the dollar still looks the best of the bunch.

 

Good luck

Double Secret Inflation

Posted on by 
In Sintra, each central bank head
From Europe, Japan and the Fed
Explained all was well
Amongst their cartel
So, ideas of changing were dead

However, in Asia it seems
The PBOC’s latest schemes
To strengthen the yuan
Have failed to catch on
Look, now, for a change in regimes

The panel in Sintra that mattered had the three key central bank heads on the dais, Powell, Lagarde and Ueda, and each one held true to their recent word.  Both Powell and Lagarde insisted that inflation remains too high and that the surprising resilience in both the US and European (?) economies means that they would both be continuing their policy tightening going forward.  Powell hinted at a July hike and Lagarde promised one a few weeks ago.  At the same time, Ueda-san explained that while headline inflation was higher than their target, given the lack of wage growth, the BOJ’s ‘double-secret’ core inflation reading was still below 2% and so there would be no policy changes anytime soon.  He did explain that if this key reading moved sustainably above 2%, it would be appropriate to tighten monetary policy, but quite frankly, my take (and I’m not alone) is that all three of these central bank heads are very happy with the current situation.

 

Why, you may ask, are they happy?  Well, politically, inflation remains the biggest headache for both Powell and Lagarde, and quite frankly most of the rest of the world, while in Japan, recent rises in inflation have not raised the same political ire.  At the same time, as long as the BOJ continues YCC and QE with negative rates, the flood of liquidity into the market there helps offset the liquidity withdrawn by the Fed and ECB.  The result of this policy mix is a very gradual reduction in total global liquidity along with an ongoing demand for US and European sovereign issuance.  It should be no surprise that Japan is now the largest holder of US Treasuries outside the Fed.  As well, the policy dichotomy has resulted in a continued depreciation of the yen which supports the mercantilist aspects of the Japanese economy.  And finally, higher inflation in Japan helps erode the real value of the 250% of GDP worth of JGBs outstanding, allowing eventual repayment of that debt to proceed more smoothly.  Talk about a win, win, win!  Until we see a material change in the macroeconomic statistics in one of these three areas, it would be a huge surprise if policies changed.

 

The upshot of this analysis is that it seems unlikely that we are going to see any substantive movement in yields, either up or down, given the relative offsets in policy, and that the yen is likely to continue to erode in value.  Last autumn, the yen fell very sharply, breaching 150 for a short time and generating serous angst at the BOJ and MOF.  We saw intervention and the idea was there was a line in the sand at that level.  However, my take is that as long as the move remains gradual, and it has been gradual as the yen has steadily, but slowly depreciated for the past 5 months, about 2%/month, we are likely to see more verbal intervention, but not so much in the way of actual activity.  In the end, unless policies change, actual intervention simply serves to moderate the move.

 

Speaking of failed intervention, we can turn to China which has a similar problem to Japan, weakening growth and low inflation.  As I have written before, a weak renminbi is the best outlet valve they have, and the market has been doing the job.  However, here the movement has been a bit faster than the PBOC would like thus resulting in more overt and covert intervention.  On the overt side, we continue to see the PBOC try to fix the onshore currency strong (dollar lower) than the market would indicate as they try to get the message across that they don’t want the currency to collapse.  On the covert side, there has been an increase in the number of stories regarding Chinese banks, like China Construction Bank and Bank of China, actively selling USDCNH, the offshore renminbi in an effort to slow the currency’s depreciation.  But the story that is circulating is that all throughout Africa and Asia, nations that were encouraged to accept CNY for sales of commodities are now quite unhappy with the CNY’s weakness and are quickly selling as much as they can in order to preserve their reserve’s value.  My sense is this process will continue as the dichotomy between a stronger than expected US economy and a weaker than expected Chinese one continues to push the renminbi lower.  PS, for everyone who was concerned about the dollar losing its reserve currency status to the renminbi or some theoretical BRICS backed currency, this should help remind you of why any change to the dollar’s global status is very far in the future.

 

And those are today’s stories.  Yesterday’s mixed US risk picture has been followed overnight with Chinese shares, both Mainland and Hong Kong, suffering but the Nikkei eking out a gain.  In Europe, the FTSE 100 is under pressure, but we are seeing strength on the continent despite what I would consider slightly worse than expected data prints in German State CPIs as well as Eurozone Confidence measures.  However, the one place where inflation slowed sharply was Spain, where headline fell to 1.9%!  While that was a touch higher than forecast, it is the first reading of any country in the Eurozone below the 2% level since early 2021.  Alas, what is not getting much press is the fact that core CPI there fell far less than expected to 5.9% and remains well above targets.  The ECB has a long way to go.

 

Bonds are under pressure across the board today, with yields higher by about 3bps-4bps in Treasuries and across Europe.  This seems to be a response to the idea that a) neither the Fed nor ECB is going to stop raising rates and b) inflation is not falling as quickly as hoped.  JGB yields, though, remain well below the YCC cap at 0.38% so there is no pressure on Ueda-san to change his tune.

 

Oil prices are creeping higher this morning but remain below $70/bbl and in truth have not done very much lately.  The big picture of structural supply deficits vs. concerns over shorter term demand deficits due to the coming recession continue to play out as choppy markets but no direction.  Copper has fallen sharply this morning and is down more than 5% in the past week.  Its recent rally appears to have been a short squeeze more than a fundamental view.  Gold, meanwhile, continues to consolidate just above $1900/oz.

 

Finally, the dollar is mixed on the day, with both gainers and losers across the EMG space although it is broadly lower vs the G10.  AUD (+0.5%) is the leading major currency after better-than-expected Retail Sales data was released overnight but the rest of the bloc, while higher, is just barely so.  In the EMG, PLN (+0.75%) is the best performer, but that is very clearly a position rebalancing after a week of structural weakness.  On the downside, KRW (-0.75%) is the worst performer after weaker Chinese data impacted the view of Korea’s future.  Otherwise, most currencies are relatively unchanged on the day.

 

We get some important data today starting with Initial Claims (exp 265K) and Continuing Claims (1765K) as well as Q1 GDP (1.4%).  Frankly, since this is the third look at GDP, I expect that the Claims data, which has been trending higher lately, is the most critical piece.  If we see another strong print, be prepared for the recession narrative to come back with a vengeance, but if it is soft, then there will be nothing stopping the Fed going forward.

 

Powell made some comments this morning in Madrid, but they were about bank stability not economic policy, and we hear from Bostic this afternoon.  But frankly, I see little reason for a change in sentiment anywhere on the Fed given the data continues to show surprising economic strength.  As such, I still like the dollar medium term.

 

Good luck

Adf

Inflation’s at Bay

Posted on by 
While waiting to hear more from Jay
Investors keep socking away
More assets that need
Low rates to succeed
With clues, now, inflation’s at bay

In Europe, the money supply
Although really still very high
Is starting to fall
As well, there’s a call
To start waving PEPP bonds bye-bye

Overall, it has been an uneventful session in the markets with risk assets generally performing well amid clues that all the central bank efforts to tame inflation may be starting to work.  The first sign was the release of lower-than-expected Italian CPI data at 6.7%, down sharply from last month’s 8.0% reading.  As well, Italian PPI continues its recent negative trend, printing at -6.8% Y/Y, widely seen as a harbinger of future CPI activity.  In addition, money supply data has continued to fall rapidly as per the below chart from the ECB, with M1 growth falling to -6.4%, its lowest reading ever.

Yesterday I mentioned the idea that the ECB was turning into a closet monetarist institution as they continue to see their balance sheet shrink and today’s data helps bolster that view.  In addition, there is increasing discussion at Sintra that the ECB should consider actually selling some of the bonds from their QE programs, APP and PEPP, rather than simply let them roll off without reinvesting.  Recall, that while the Fed is allowing $95 billion / month to mature without reinvestment, the ECB’s pace is a mere €15 billion / month.  Granted, the ECB also has the benefit of having a large slug of TLTRO loans maturing this week (approximately €500 billion) which has been the driving force behind their balance sheet’s decline, but whatever is driving the process, it seems like the ECB is tightening monetary policy more aggressively than the Fed. 

 

The big difference between the US and Europe, though, is that Europe is already clearly in a recession while the US, despite a widely anticipated slowdown, continues to perform quite well.  For instance, yesterday’s data releases were uniformly better than expected.  Durable Goods, Home Prices, New Home Sales, Consumer Confidence and the Richmond Fed Manufacturing Index all printed at better levels than expected.  This goes back to the Citi Surprise Index, which jumped nearly 17 points yesterday after the releases and sits firmly in positive territory in an uptrend.  Meanwhile, the same measure in the Eurozone is collapsing, deep in negative territory.  The below Bloomberg chart is normalized at 100 from one year ago.  It is quite easy to see the remarkable gap between the US (blue line) and Eurozone (white line) with respect to relative economic performance.

Arguably, one would expect that given the US economy’s seeming resilience, the Fed would be the more aggressive of the two central banks, but that is just not the case, at least based on the behavior of their respective balance sheets.

 

The big question is, can this dichotomy continue?  With the Eurozone already in a recession and showing no signs of coming out of it, can the ECB continue to tighten policy in the same manner they have to date?  As well, can the US equity market continue to perform well despite no indication that the Fed has any reason to pivot to easier money in the near future?  Logically, at least based on previous logic, one would have thought these conditions could not continue very long.  And yet, here we are with no obvious end in sight. 

 

My sense, and my fear, is that the ‘long and variable lags’ with which monetary policy impacts economic activity have not yet been felt in the US economy and that much more stress is still in the not-too-distant future.  If I had to select a particular weak spot it would be commercial real estate, especially the office sector, as already we have seen a number of high-profile mortgage defaults, and given the change in working conditions for so many people and companies, are likely to see many more.  The GFC was driven by the retail mortgage sector imploding.  It is not hard to imagine the next financial downturn being driven by the inability of commercial mortgage holders to refinance over the next year or two as they are currently upside down on their properties and cash flows are suffering dramatically to boot.  If this sector is the genesis of the problems, then given local and community banks are quite exposed to the sector all over the country, we are likely to be in for a rough ride, both in the economy and the stock market.  Be wary.

 

As to the overnight session, generally speaking, equity markets followed yesterday’s US rally with gains.  Japan was the leader with the Nikkei rallying 2% and only mainland China suffered as there was less clarity that the Chinese government was going to support the economy, and the currency.  European bourses are all nicely higher although US futures, especially the NASDAQ, are a bit softer after the Biden administration indicated further restrictions on semiconductor sales to China.

 

Bond yields are sliding a bit this morning but not too much, 2bp-3bp and quite frankly, all remain in a fairly narrow trading range.  Despite the Treasury issuance onslaught that has been proceeding since the debt ceiling was eliminated, yields have not moved very far at all.  It would seem that as issuance is pushed further out the maturity ladder, we would see higher yields, but that has not been evident yet.  Meanwhile, the yield curve remains massively inverted, right at -100bps this morning.

 

Oil prices are stabilizing this morning but have fallen more than 6% in the past week as this is the one market that truly believes the recession story.  Gold is also under pressure, falling further and pushing toward $1900/oz.  Higher yields continue to undermine the barbarous relic.  As to base metals, copper is under pressure, but aluminum is holding in reasonably well. 

 

Finally, the dollar is rebounding from a few days of softness with strength virtually across the board this morning.  Every G10 currency is weaker led by NZD (-1.3%) and AUD (-0.95%) as concerns over Chinese economic activity weigh on the antipodeans.  But the whole bloc is under pressure.  Meanwhile, in the EMG space, the picture is the same, virtual unanimity in currency weakness led by ZAR (-1.0%) and THB (-0.95%) with CNY (-0.3%) reversing course after the PBOC was absent from the market last night.  Despite hawkish comments from the SARB, the rand continues to suffer over concerns about the broader economy while the baht is suffering from political concerns.  This is an interesting story as Pita Limjaroenat was the surprise victor in recent elections but was not backed by the military.  Not surprisingly they are not happy, and he is having trouble putting a government together.

 

There is no major data today, so we are all awaiting Chairman Powell’s comments at 9:30 to see if he has any further nuance to impart.  At this point, I have to believe he will continue to push the higher for longer mantra as the data has certainly done nothing to dissuade him.  As such, I still like the dollar over time.

 

Good luck

Adf

No Longer Clear

Posted on by 
Inflation remains
Far higher than desired
Will Ueda-san blink?

Which one of these is not like the other?

 

Central Bank

Policy Interest Rate

Core CPI

Federal Reserve

5.25%

5.3%

ECB

4.00%

5.3%

BOE

5.00%

7.1%

Bank of Canada

4.75%

4.2%

RBA

4.10%

6.8% (headline)

BOJ

-0.10%

3.2%

Source: Bloomberg

 

Japanese inflation readings were released overnight, and they showed no signs of declining.  In fact, they were actually a tick higher than the median forecasts.  However, there has been zero indication that the BOJ is set to respond to the highest inflation in decades.  As everything economic is political, by its very nature, the reality seems to be that there is not yet any political price for PM Kishida to pay for rising inflation.  Recall, as inflation started to pick up sharply in the wake of the pandemic reopenings, the universal central bank response was, inflation is transitory and it will subside soon.  Politically, at that time, governments were keen to keep interest rates near (or below) zero as part of their belief that it would foster economic activity and recession was the big concern.

 

However, once it became so clear that even central banks understood this bout of inflation was not a transitory phenomenon, policy prescriptions changed rapidly leading to the very rapid rise in interest rates we have seen since early 2022.  Politically, inflation was the lead story in every media outlet with governments around the world and their central banks being blamed, so they had to respond.  (Whether their response has been effective is an entirely different story).  Except in one place, Japan.  As is abundantly clear from the table I constructed above, the BOJ has yet to alter their monetary policy stance despite core CPI remaining at extremely elevated levels far above the BOJ’s 2% target.  In fact, prior to the recent spike, you have to go back to 1981 to see Japanese core CPI this high.

 

Apparently, though, inflation is not making headlines in Japan as it has been throughout the rest of the G7 and so the BOJ is perfectly happy to continue on their path of infinite QE and YCC.  Remarkably, 10-year JGB yields fell further last night, now around 0.35%, as there is seemingly very little concern that a policy change is in the offing there.  Certainly, there has been no indication from any BOJ commentary nor from Kishida’s government.  As such, it can be no surprise that the yen continues to fall, declining 1% this week and more than 3% over the past month. 

 

Interestingly, there has definitely been an uptick in the buzz from market talking heads about the need for the BOJ to abandon YCC and that a change is imminent.  I have seen a number of analyses that foretell of the inevitable change and how the yen is likely to rise dramatically when it happens.  FWIW, which may not be that much, I agree that when the BOJ does change policy, we are likely to see the yen rally sharply.  The problem is, I see no indication that is going to happen anytime soon.  Show me the headlines in the Asahi Shimbun or the Nikkei Shimbum (major Japanese newspapers) that are focused on inflation and I will change my view.  But until it is a political problem, the BOJ is serving its current function of supplying the world’s liquidity with a correspondingly weaker yen as a result.

The messaging’s no longer clear
Regarding the rest of the year
While some at the Fed
See more hikes ahead
Some others feel ending is near

Once again yesterday we heard mixed messages from Fed speakers with some (Barkin) talking about evaluating their actions so far and waiting for more proof that further tightening was needed while others (Bowman, Waller) seeming pretty clear that more hikes are in the offing.  Powell’s Senate testimony was largely the same as the House testimony on Wednesday with more of the questions focused on bank capital rather than monetary policy.  Of course, the big question remains, are they done or not?  Fed funds futures are still pricing a 72% chance of a hike in July and a terminal rate of 5.33%, so one more hike from current levels.  But the arguments on both sides remain active.  It appears to me that as long as the employment situation remains robust, they will continue to hike until inflation falls closer to their target.  Yesterday’s Initial Claims data printed just a touch higher, 264K, and the trend certainly seems to be moving higher, but is not nearly at levels consistent with recession.  The NFP report in two weeks will be critical but until then, we are likely to be whipsawed by commentary.

 

As to the overnight session, risk is very definitely on its heels this morning with equity markets in the red around the world, with all of Asia falling by -1.5% or more although European bourses have not suffered quite as much, -0.3% to -0.8%.  US futures are also under pressure, down about -0.5% at this hour (8:00).

 

Bond markets, on the other hand, are performing their role as safe haven, with yields sharply lower this morning. Treasury yields, which had risen yesterday have given all that back and then some, down 6bps, while in Europe, sovereigns are down 12-13bps virtually across the board.  The latter seems to be a response to the Flash PMI data which was released showing slowing activity across the continent, especially in France where both Manufacturing and Services fell below 50 and where German Manufacturing PMI tumbled to 41.0.  If the Eurozone economy is truly performing so poorly, it is hard to believe that the ECB will continue on its current path much longer.  One other rate story is the short-term GBP rates which are now pricing a terminal rate by the BOE at 6.13%, pricing another 5 rate hikes into the curve by the middle of next year.

 

However, on this risk off day, it is the dollar that is truly king of the world, rallying vs every one of its counterparts in both the G10 and EMG.  NOK (-2.2%) is the G10 laggard on the back of general risk aversion as well as the fact that oil prices are tumbling again, down a further -1.25% this morning on the recession fears.  But the weakness is pervasive with AUD (-1.0%) weak and the euro (-0.7%) giving up chunks of its recent gains in short order.  Interestingly, the yen (-0.1%) is the best performer in the G10.  The picture in the emerging markets is similar, with substantial losses across the board led by TRY (-1.3%) and ZAR (-1.1%).  Of course, Turkey’s lira is destined to continue collapsing given the dysfunctional monetary policy there, but ZAR is feeling the pressure of declining metals prices, especially gold, which is down again this morning and now pressing $1900/oz.  Meanwhile, China’s renminbi continues to slide, trading to new lows for this move with the dollar marching inexorably higher.

 

On the data front, today brings Flash PMI data (exp 48.5 Manufacturing, 54.0 Services, 53.5 Composite) and that’s it. Two more Fed speakers, Bullard and Mester, are due to speak and both have been leading hawks so we know what to expect.  So, looking at the rest of the session, I suspect that the dollar will maintain most of its gains, but do not be surprised to see a little sell off as we head into the weekend and positions are reduced.

 

Good luck and good weekend

Adf

A Pitiful Claim

Posted on by 
Said Jay, we’ve “a long way to go”
Ere driving inflation too low
Employment’s still tight
But we’ll get it right
Or not… it’s too early to know

His colleagues, though, aren’t in sync
As some of them seemingly think
They’ve tightened enough
And now would rebuff
The call for more Kool-Aid to drink

Lots to touch on this morning between Powell’s testimony yesterday along with other Fed speakers and then a raft of central bank meetings with rate hikes across the board.

 

Starting with the Fed, Powell tried to be very clear that his expectation, and that of the bulk of the FOMC, is interest rates have further to rise.  While they chose to skip a hike last week, they are under no illusion that they have beaten inflation.  Instead, Powell was very clear in his comments that they “have a long way to go” before they have finished the job with inflation.  Of course, yesterday I laid out a theme of why their medicine for inflation is not likely to be that effective, but that is not a conversation that Powell, or any FOMC member, is likely to entertain.

 

However, despite Powell’s insistence that there are likely two more 25bp rate hikes in the offing, we are finally beginning to hear some dissent from the rest of the committee.  Yesterday both Raphael Bostic from Atlanta and Austin Goolsbee from Chicago were clear that a pause at the current level made the most sense and they would support that outcome.  While Governor Christopher Waller remains on board with further rate hikes, Bostic is not a voter (Goolsbee is) so I expect that the July meeting will have a lot of discussion.

 

Interestingly, the market reaction was different in different markets, with the equity markets hearing Powell and accepting his words at face value thus selling off, while the FX market seems more suspect, with the dollar failing to gain after his comments.  In fact, the euro has traded back above 1.10 this morning for the first time in more than a month.  As to the Treasury market, yields are pushing higher again, with 10yr yields up by 1.5bps this morning, but the real movement has been in the 2yr which has seen the curve inversion push back to -99bps.  Bond investors seem to believe Powell.

In Europe, though, things ain’t the same
As central banks still try to blame
Their failure to slow
Inflation and grow
On Russia, a pitiful claim

In the meantime, three central banks met today in Europe and all three hiked rates, with two, Norway and the UK, hiking by 50bps and Switzerland hiking just 25bps.  The 50bp hikes were more than expected and indicative of the fact that both nations, and in truth the entire continent, remain far behind the curve in their respective inflation fights.  Alas, for these nations, too, I fear they are not using the best tool to address the issue as all were guilty of excessive fiscal stimulus and all face worse demographic trends than the US, so are unlikely to get the desired response from rate hikes. 

 

It should be no surprise that both the pound and krone have rallied sharply on the day, with NOK higher by 1.3% and the best performing currency in the world, as investors and traders are concluding that these central banks are going to keep at it until such time as inflation finally does slow down.  The pound reacted immediately, with a quick 0.5% pop, although it is since retraced those gains and is only slightly higher on the day now. 

 

What should we make of all this central bank activity?  While there are a growing number of analysts and economists who continue to believe that inflation is due to decline sharply over the summer, apparently none of them work in any central bank.  The relative amount of tightness from one bank to another may vary slightly, but other than the BOJ, which is completely uninterested in adjusting its policy anytime soon, it is very easy to believe that interest rates have higher to go from here.  Plan accordingly.

 

So, what have these comments and actions wrought in markets?  Well, my entire equity market screen is red this morning with Japan and China both sharply lower as well as every major index in Europe falling by at least -1.0%.  US futures are also in the red after a weak session yesterday, and it is very easy to believe that we are due a correction, if nothing else, given the remarkable run up we have seen lately.

 

Bond yields, as mentioned above, are generally higher, although 10yr Gilts are bucking the trend, falling 3bps in the wake of the BOE action as investors are hopeful they are truly going to be able to halt the inflationary spiral.  As with most other things, JGB’s are not following suit and in fact, with the 10yr yield back down to 0.367%, virtually all discussion of the end of YCC has vanished.  Ueda-san is one lucky guy.

 

On the other hand, oil (-2.1%) is under pressure this morning as the idea of higher interest rates slowing economic growth continues to pervade the market.  Perhaps more surprisingly, both copper and aluminum have rallied a bit and are holding onto their gains in the face of higher rates.  Ultimately, copper especially, is a resource that is in short supply for all the grandiose electrification plans that are bandied about by politicians worldwide, and so I expect, just like oil, there is a structural deficit and it should trade higher.  I am simply surprised it is doing so in the current environment.

 

Finally, the dollar is mixed this morning, as after the NOK, the rest of the G10 is +/- 0.2% from yesterday’s closing levels, hardly enough to discuss.  In the emerging markets, the biggest mover is TRY (-2.3%) after the central bank disappointed by only raising rates from 8.50% to 15.0%!  With a new central bank chief, the market was expecting a move to 20.0%, which would still be far below the current level of CPI there, which at last reading was 39.6%.  But away from that, the dollar is mixed with no outliers in either direction.

 

Today we do get a lot of data as follows: Chicago Fed National Activity Index (exp -0.10); Initial Claims (259K); Continuing Claims (1785K); Existing Home Sales (4.25M); Leading Indicators (-0.8%) and KC Fed Manufacturing Index (-5).  Chair Powell also speaks to the Senate Banking Committee today, but I doubt much new will come from that.  Look at the Initial Claims data, which is the best real time indicator of the employment situation as any jump there will likely get tongues wagging about the end of the Fed rate hikes.

 

Right now, investors are a bit nervous about just how hawkish the Fed is going to ultimately be, so my take is we will see caution, meaning profit taking and a modest correction in risk assets, until such time as participants are all convinced that the pivot is coming.  The fact that a pivot means the economy is distressed does not seem to matter right now. As to the dollar, it will have a hard time as long as traders question the Fed’s conviction while other central banks raise rates.  So, while the yen and renminbi should be the worst performers, the G10 is likely to outperform the buck for now.

 

Good luck

Adf

4% is the New 2%

Posted on by 
The Kingdom that’s sort of United
Reported inflation’s ignited
And simply won’t fall
Regardless of all
The rate hikes that they’ve expedited

But of more importance today
Is hearing what Jay has to say
He’ll speak to the House
Whose members will grouse
Though their views will not hold much sway

Starting with the first big data point, CPI in the UK was higher than expected yet again, printing at 8.7%, unchanged from April’s reading and above the 8.4% consensus expectation.  Core CPI actually rose further, to 7.1%, a new high reading for the current bout of inflation and an indication that thus far, the BOE has not been very effective in fighting inflation.  The market response was mostly in line with what one would expect as the equity market sold off alongside Gilts as yields climbed further.  In fact, 2yr Gilt yields are now above 5.0% for the first time since 2008 and the UK yield curve is also steeply inverted, albeit not as steeply as the US curve.  As well, the OIS market is now pricing a one-third probability of a 50bp rate hike by the BOE when they meet tomorrow.  But weirdly, the pound is under pressure this morning.  It is the worst performing G10 currency (-0.4%) and unlike most recent market reactions, where higher interest rates lead to currency strength, it has a throwback feel to your old International Finance textbooks where higher inflation leads to currency weakness.

 

Arguably, the biggest problem that Governor Bailey has right now is that it doesn’t seem to matter what the BOE does, prices are continuing to rise.  My sense is that interest rate hikes may not be the right medicine for the UK’s current ailments (which could well be true in the US) as the genesis of this inflation is not excessive economic growth driving demand but rather fiscal policy profligacy driving demand.  If it is the latter, then higher interest rates may only exacerbate the inflation situation as the increased cost of debt service simply adds to the growing budget deficit which increases the amount of money available for people to spend.  Consider, if one owns 2yr Gilts yielding 5%, the amount of income available to that person/entity is far greater than when 2yr Gilts were yielding 1% two years ago and so there is more money to spend.  Just like in the US, the employment situation in the UK remains tight and wages are rising along with interest rates.  In other words, there is a lot more money floating around chasing goods, a pretty surefire recipe for increasing inflation.  Alas, this idea doesn’t fit well within the Keynesian dogma so I fear things will take a long time to recover in the UK.

 

Turning to the US, this morning we will hear from Chairman Powell for the first time since the FOMC meeting a week ago as he testifies before the House Financial Services Committee.  While it is always difficult to anticipate what types of questions people like Representative Maxine Waters (who thankfully no longer chairs this committee) will ask, I expect that there will be a lot of discussion regarding whether the Fed should continue tightening policy in the face of recent softer, albeit still high, inflation readings, and what is being done about issues like bank safety and oversight.  I am also quite confident that there will be questions/demands for the Fed to do something about climate change although Chairman Powell has already made clear it is not in their mandate.

 

However, ex ante, trying to assess what Powell is likely to say, I would estimate he will continue with the current Fed mantra of inflation remains far too high and that they are going to bring the rate of inflation back to their 2% target.  He is also likely to admit that doing so will cause pain via rising unemployment, something no Congressman/woman is going to want to hear.  But just like in the UK as explained above, it is entirely possible that the Fed’s reading of the current situation may not be accurate.  The playbook, as written by Paul Volcker, explains that the way to squash inflation is to raise interest rates high enough to cause a recession, kill demand and watch price increases end.  And that worked well in 1980-1982 as the US was dealing with both rising commodity prices as well as a demographic boom as Baby Boomers were entering the workforce along with women and there was a significant uptick in activity and productivity. 

 

The problem for Powell, who came of age during that period, is that is not very descriptive of today’s economy.  Instead, we have just come through a massive fiscal policy spend on the back of the pandemic response (similar to the end of a war) but the demographics are far less impactful as population is growing far more slowly and the working population is growing even slower.  Higher interest rates have increased the income for retirees and allowed them to increase demand as they spend that newfound money.  I’m not saying that cutting rates is the right path, just that raising them a lot more may not be very effective either.  Fiscal discipline would be a far more effective tool to fight inflation in the current environment I believe.  Alas, that is something that simply no longer exists.  As such, I fear that we are going to see inflation remain much higher than we had become used to for a much longer time.  I expect 4% is the new 2%.

 

At any rate, ahead of the Powell comments, which begin at 10:00am, this is what we’ve seen overnight.  Japanese equities continue to rock, rising again and now up nearly 29% YTD in yen terms.  The Nikkei has reached its highest level since December 1989, although has not yet passed the peak set in September of that year.  However, Chinese equities are on a completely different trajectory right now, with both the Hang Seng and mainland indices down on the year.  It seems investors are not enamored of President Xi’s economic leadership right now.  As to Europe, it is mostly softer, albeit not by much and US futures are similarly down slightly ahead of the opening.

 

Bond yields are edging higher outside of the UK with Treasuries back up 3bps and most of the continent up around 1bp.  Looking at Treasury activity lately, it has been choppy but not trending either higher or lower and sits in the middle of the 3.50% – 4.0% range that has defined trading since September.

 

Oil prices are little changed this morning and are also hanging about in a range lately as the market tries to determine the supply/demand function.  Is China growing enough to increase demand substantially?  How much oil is Iran getting into the market?  These are the questions that have no clear answers so visibility into trends is limited.  Meanwhile, gold got clobbered yesterday on dollar strength and the base metals had a similar response.

 

Finally, the dollar remains stronger rather than weaker overall, rallying yesterday against most of its counterparts and holding the bulk of those gains.  Today’s outlier is KRW (-0.9%) which suffered after the release of its export data showed a 12.5% decline of exports to China.  In truth, this bodes ill for both currencies, the won and the renminbi, which saw the offshore version trade through 7.20 last night for the first time in this move.  As I have written before, this has further to go.

 

There is no data today so basically, all eyes will be on the tape at 10:00 to hear what Powell has to say and how he responds to the questions.  For now, the market is losing conviction that another rate hike is coming, although there is no indication from Fed speakers that they have changed their view.  Next week, we will see the PCE data, and I suspect much will depend on how that prints before any new views can be expressed.  In the meantime, the dollar is caught between a sense of risk-off and a sense the Fed may be done.  Choppy is the name of the game.

 

Good luck

Adf

 

Policy Lies

Posted on by 
In China Xi’s growing concerned
That growth there will not have returned
Ere folks recognize
His policy lies
And seek changes for which they’ve yearned

So, last night they cut interest rates
While hoping it’s this that creates
The growth that is needed
So, Xi’s unimpeded
In ending all future debates

It has been another relatively dull session in markets as we are well and truly amid the summer doldrums despite solstice not arriving until tomorrow.  After an action-packed week with numerous central bank meetings as well as key inflation readings, this week is looking a lot less interesting.  From a market perspective, the most noteworthy news from overnight was the reduction in the Loan Prime Rate in China by 10 basis points, matching what we saw in their repo rates last week.  This is a very clear signal that there is a growing concern at the top in China regarding the growth trajectory of the country. 

 

Perhaps the most interesting part of this situation is the reversal of previous policy attempts to reduce property speculation with the latest message encouraging people to buy a second home!  It was only a few years ago when China, having massively leveraged its economy to generate their much vaunted 6% growth rate, realized that too much debt could turn into a problem.  This led to a policy change that discouraged property investment and ultimately led to the decimation of the property sector.  China Evergrande was the first major problem revealed, but there have been numerous other companies whose business model collapsed along with many people’s life savings. 

 

However, lately that story has been just background noise and represented just one of the many industries that the Xi government helped undermine.  You may recall the education (tutoring) companies that were turned into non-profits overnight, and the fight against the large tech companies like Alibaba and TenCent, which were deemed to be getting too powerful.  But a funny thing about a state-controlled economy is that business decisions made by government actors are typically abysmal and lead to further problems.  So, when the government decided that property speculation was bad, they cracked down hard.  But now that they are figuring out that much of the country’s wealth was tied up in the market they cracked down on, and that people reduced their economic activity accordingly, they realize that perhaps things were better with that speculation, at least politically.  Hence the reversal where the government is now encouraging that purchase of a second home.  You can’t make this stuff up.

 

At any rate, the one thing that is very clear is that the Chinese economy is continuing to drag and that the most natural outlet remains the renminbi, which weakened further last night (-0.3%) and continues to push toward the renminbi lows (dollar highs) seen in November 2022.  Given inflation remains extremely low there and given that the only model that the Chinese really know, the mercantilist export driven process, benefits from a weaker CNY, I would look for this trend to continue for quite a while going forward.

 

Otherwise, last night saw the release of the RBA Minutes which indicated that the surprise rate hike of a couple weeks ago was a much more closely debated outcome than previously thought.  This has led traders to downgrade their assessment of a rate hike next month and Aussie (-0.9%) fell accordingly.

 

Beyond those stories, though, there is precious little to discuss today.  Risk is on its back foot with equity markets in Europe mostly under pressures, and Chinese markets, especially, seeing weakness led by the Hang Seng’s -1.5% performance.  US futures are also a bit lower at this hour (7:30) following Friday’s lackluster session.  As discussed yesterday, there remains an active dialog between the bulls and the bears, with the bulls having the better of it for now, but the bears unwilling to give in.  My working assumption is we need that to occur before things can turn around, so we shall see.

 

As to the interest rate outlook, opposite the Chinese rate cuts, the Western markets continue to price in further rate hikes as inflation remains far above target levels throughout 6 of the G7 with only Japan maintaining their current QE/NIRP policies.  I think of greater concern for many economists is the fact that the inversion of the Treasury curve is not only substantial but has been increasing lately and is pushing back to -100bps for the 2yr-10yr spread.  Perhaps, after 11 months of this price action, the question needs to be asked if this is a natural occurrence and a clear signal for a recession in the not too distant future, or if there is something else happening, perhaps an artificial bid in the back end via Japanese QE, maintaining much lower than realistic long-term rates as a way to prevent the US government’s interest expenses from rising too rapidly.  With that as backdrop, though, it must be noted that European sovereign markets are much firmer this morning with 10-year yields all sharply lower, 6bp-7bp on the continent and 14bps lower in the UK after a new issuance with the highest coupon (4.5%) in decades drew substantial demand.

 

In the commodity markets, oil is relatively flat today having recaptured the $70/bbl level last month and to my mind seems to have found a bottom.  While gold is flat and continuing its consolidation, base metals markets are under a bit of pressure on this risk off day.

 

Finally, the dollar is generally a bit stronger, at least vs. its G10 counterparts, with only the yen (+0.4%) showing its haven characteristics while essentially the rest of the bloc has fallen about -0.35%.  In the emerging markets, the picture is more mixed with about half the currencies slightly stronger and half weaker but none having moved more than 0.3% in either direction, an indication that this is positional not newsworthy.

 

Looking ahead, this week brings mostly housing data but of more importance, we hear from Chairman Powell twice as he testifies to both the House Financial Services Committee and the Senate Banking Committee tomorrow and Thursday respectively.  We also hear from the BOE on Thursday with another 25bp rate hike expected there.

 

Today

Housing Starts

1400K

 

Building Permits

1425K

Thursday

Chicago Fed National Index

-0.10

 

Initial Claims

260K

 

Continuing Claims

1785K

 

Existing Home Sales

4.25M

 

Leading Indicators

-0.8%

Friday

Flash PMI Manufacturing

48.5

 

Flash PMI Services

54.0

 

Flash PMI Composite

53.5

Source: Bloomberg

 

I think we can expect Powell to continue the hawkish rhetoric and he will do so until either inflation is very clearly lowered, as measured by the regular data, or until the Unemployment rate starts to rise sharply.  However, the market is becoming of the opinion that Madame Lagarde and Governor Bailey will be more hawkish than Powell.  This has been the driver for the dollar’s relative softness over the past month.  In contrast, I remain quite confident that if Powell does pivot, it won’t be long before both the ECB and BOE do the same.

 

Good luck

Adf