Tag Archives: #Powell

No Longer Clear

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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

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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

The Battle’s Been Won

Posted on by 
‘Bout Jay and the FOMC
The market has come to agree
The battle’s been won
And hiking is done
So, buy stocks with verve and with glee

In Europe, though, Madame Lagarde
Is finding that things are still hard
Inflation’s not tamed
And she will be blamed
If prices, she cannot retard

Meanwhile on the world’s other side
Where growth has begun to backslide
The PBOC
More cash will set free
As Xi tries to hold back the tide

When looking at the market activity yesterday, it is easy to conclude that the market believes the Fed has instituted their last hike.  This was evident in the equity market’s performance where all three major indices rallied more than 1% and it was evident in the FX market where the dollar was pummeled, falling by 1% or more against 7 of its G10 counterparts as well as about half the EMG bloc.  In addition, Treasury yields fell sharply as the idea that the Fed is going to continue hiking, as implied by Chairman Powell in his comments on Wednesday, seems to have faded from memory. 

 

But that’s not all!  While key markets are beginning to discount any further Fed activity, the ECB not only raised their rate structure by 25bps as expected, but Madame Lagarde essentially promised another hike in July and this morning the ECB’s hawks are circling and hinting that a September rate hike is quite possible as well. 

 

Now, we already know that the Fed’s dot plot is calling for 2 more rate hikes this year, but the Fed funds futures market is not in accord with that view.  Rather, it is pricing a 70% probability of a July hike as the final move.  But, will they hike again?  Clearly, between now and the end of July we will all have seen a great deal more data, including both an NFP and CPI report, and that will have a major impact on the Fed.  But after yesterday’s US data dump, which showed Retail Sales holding up far better than expected while both the Import and Export Price Indices showed price declines, there has been a significant increase in the chatter of the Fed pulling off a soft landing after all.  And, if the landing is soft, do they need to hike more?

 

Although the manufacturing side of the economy remains lackluster, Services have been killing it.  There is one other reason to believe the Fed will remain on hold as well, and that is the employment situation.  While we have seen a much hotter than forecast NFP print basically each month for the past year, we are starting to see Initial Claims data tick higher.  Yesterday’s 262K was both higher than expected and the highest print since October 2021 when claims were tumbling during the post-pandemic recovery.  More ominously, the 4-week and 13-week moving averages (analyzed to seek a trend and remove the weekly choppiness) are both clearly trending higher.  If that number continues to rise, the Fed’s confidence in the economic recovery continuing is likely to be impaired.  In fact, I think this is the feature that is most likely to cause the Fed to stop hiking.

 

If we pivot to Asia for a moment, we see a completely different set of concerns in both China and Japan.  Starting with China, after cutting their lending rates earlier this week, the PBOC is still struggling to figure out how to support what is a clearly softening economy.  Although there has been much lip service paid to the fact that China will no longer prop up the property market and investment and is instead seeking to generate more domestic consumption, the fact that the youth unemployment rate is at a record 20.8% and that the only playbook the Chinese really understand is infrastructure spending and leveraged property speculation, they are falling back into that trap.  Rumors abound that the government is going to put forth a CNY1 trillion (~$140B) spending package and that the PBOC is going to ease restrictions on property lending, removing the ban on second home purchases in small cities.  Remember, property speculation was a critical part of China’s rapid growth as people there have little confidence in a social safety net and were using those second homes as an investment to secure their nest egg.  Alas, with China’s population shrinking, that may no longer be an interesting investment for the middle class.  So, while China’s problems are different, they are no less severe than those in the West.

 

Uncertainty is
“Extremely high” over both
Wages and prices

So, Ueda-san
Will keep liquidity flows
Like flooding rivers

As to Japan, I’m old enough to remember when there was a growing belief that once Kuroda-san stepped down as BOJ head, his replacement would have free rein to tighten policy. Boy, were we ever wrong about that.  After last night, while there was no policy adjustment as expected, Ueda-san’s comments can only be construed as strongly dovish and the market got the message.  JGB yields slid a few basis points and are back below 0.40% while the yen is the only currency that is underperforming the dollar.  Meanwhile, the Nikkei (+0.65%) continues its recent strong performance as the second best major index after only the NASDAQ.

The one thing that we know is that things do not seem to be evolving as per much of the consensus from earlier this year.  While there is still a long way to go before this cycle ends, and I still expect a more significant economic slowdown globally, the possibility that Chairman Powell pulls off a soft landing cannot be dismissed.  And as I saw on Twitter yesterday, if he does so, he will be hailed as the greatest Fed chair ever, even more so than Paul Volcker.  Alas, I fear things will not work out that way.  Remember that monetary policy works with long and variable lags, and I would contend that the economy is likely just beginning to feel the true impacts of tighter policy.  Now, this may only happen in the manufacturing sector, where the cost of capital is such a critical input, but history has shown if that sector stumbles, it drags the economy down with it.  Remember that so much of the service economy exists to service manufacturing, so the two are quite intertwined.

Remember, too, there are potential exogenous shocks, both positive and negative, that can have a big impact.  What if the Ukraine war ended?  What if China invaded Taiwan?  What if there was an escalation of fighting in the Middle East with a dramatic reduction in oil production?  All I am pointing out is that myopically focusing on just the economic data is not sufficient for a risk manager.  Sh*t happens and it can matter a lot.

Ok, as to today, we already know that risk is on.  The data coming out this morning is Michigan Sentiment (exp 60.0) and of the three Fed speakers, two have already commented with Governor Waller not talking economics or policy, but rather bank regulation and Bullard was more theoretical than policy focused, so really there has been nothing new there either.  In a little while, Richmond’s Barkin will discuss inflation, so that could be interesting.  But for right now, the market has made up its mind.  Everything is right as rain so add risk.  That means the dollar is likely to remain under pressure with a test of its lows (EUR 1.11, DXY 102) coming soon to a screen near you.

Heading into a bank holiday weekend, I expect positions to be lightened but the recent dollar weakening trend to remain intact.

Good luck and good weekend

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Which One Means More?

Posted on by 
The question is, which one means more?
The headline inflation? Or core?
The former declined
But please bear in mind 
The latter rose more than before

Which brings us today to the Fed
Where skipping a rate hike is said
To be what they’ll try
Then come late July
Will hike ere more water they tread

By now you are all aware that CPI’s release yesterday was a bit of a mixed bag with the headline number falling slightly more than expected to 4.0% while the core (ex food & energy) fell slightly less than expected to 5.3%.  As always, my go-to source on inflation is @inflation_guy, who in yesterdays’ post clearly laid out that there is very limited evidence that core inflation is going to decline sharply from these levels anytime soon.  In a nutshell, the key issue is that the housing portion of the index remains robust and that represents slightly more than one-third of the entire reading. 

 

Ask yourself the following question; why would a landlord reduce his asking rents if his costs are rising (taxes and maintenance) and his potential customers are all seeing wages rise healthily, at least as per measured by the BLS and the Fed?  Of course, the answer is that landlord is unlikely to reduce rents, but rather raise them, and that is not going to feed into lower inflation.  One other thing to note is the price of energy, which was the key driver of the decline in headline CPI, has the earmarks of a bottom here.  Not only have we seen production cuts from OPEC+, but it appears the Biden administration is beginning the process of finally refilling the SPR which means they have likely mapped the bottom of oil prices which have rebounded more than 5% from the lows seen Monday after the news broke.

 

As expected, the equity market took this news as a huge positive and continued its recent rally as it is almost certain that the Fed will be holding rates unchanged when they announce their policy update this afternoon.  The Fed funds futures market has reduced its pricing for a rate hike to just 9% this morning although the implied probability of a hike in July has risen to 71% now.  As an aside, the futures market is still pricing in the first rate cut by December or January 2024, although I suspect we will need to see a more significant decline in economic activity with much higher Unemployment for that to come to fruition.

 

This afternoon’s FOMC statement, and more importantly Chairman Powell’s press conference are the next critical features for the market.  There is much talk of this being a ‘hawkish pause’ where they will not change rates but really play up the still hot core inflation data to make sure that everyone knows they are not going soft on inflation.  As I have repeatedly explained, I continue to look at NFP as the most critical data point these days because as long as that number keeps printing solidly and beating expectations, the Fed will not be overly concerned a recession is coming and will feel comfortable tightening further if inflation starts to tick higher again.  And so, at this time, all we can do is wait for the outcome at 2pm.

 

Ahead of that, here’s what’s been happening:  risk has largely been in favor as yesterday’s US equity rally was followed by strength in Japan (+1.5%) and Australia (+0.3%) although many other APAC markets, notably China and South Korea, fell.  The China situation is quite interesting as there is news that the Chinese government has convened several meetings with business leaders to get ideas as to how to improve the economy there.  Not surprisingly, according to a Bloomberg story, the discussions focused on more market-oriented actions and less state planning as well as better coordinated fiscal and monetary policy stimulus.  My guess is that President Xi is not keen to let the market do the work as he will not control that, so it will be interesting to see how things there progress.  Meanwhile, European bourses are all much stronger this morning, even the FTSE 100 (+0.6%) despite a modestly weaker than expected set of GDP and IP data being released.  And of course, US futures continue to edge higher, at least NASDAQ futures do, although it would be quite surprising to see any large movement ahead of the FOMC this afternoon.

 

Of much greater interest to me is that bond yields rose so sharply yesterday with 10yr Treasuries rising 7 bps yesterday and another 1.5bps this morning, despite (because of?) the CPI data being soft.  The curve inversion remained essentially unchanged at -85bps, so I guess the story I saw that might have been the driver was when Treasury secretary Yellen was asked in Congressional testimony about the Fed and Treasury being prepared if China were to liquidate their entire portfolio of Treasuries, which is ~$875 billion.  That seems highly unlikely to me, but I guess anything is possible.  European sovereign yields are also rising after gains yesterday, which seems at odds with the equity markets that clearly believe in lower inflation.  Things are quite confusing these days.  As well, there will be much attention paid to China tonight to see if the PBOC follows through with a 10bp rate cut in the 1yr lending facility, or perhaps, if they are concerned about economic weakness, opts for more.

 

As mentioned, oil prices continue to rebound, pushing back to $70/bbl while gold got crushed yesterday seemingly in response to the rise in Treasury yields.  This morning the barbarous relic is ever so slightly firmer but in a bigger picture view, remains relatively unchanged over the past month.  Copper has continued its recent countertrend rally, but I expect that we will need to see real signs of an economic rebound for the red metal to get back to levels seen earlier this year above $4.00/pound.

 

Finally, the dollar remains under modest pressure overall, sliding about 0.25% against most of its G10 counterparts and a bit further against several EMG currencies.  Notably, ZAR (+1.0%) is the best performer today, after a solid Retail Sales print this morning.  As well, we see PLN (+0.7%) rising on rising zloty yields after the government increased the budget deficit on increased spending.  On the downside, KRW (-0.55%) is the laggard, falling after several days of a sharp rally has led to profit-taking.

 

Ahead of the Fed, we see PPI this morning (exp 1.5%, 2.9% ex food & energy) although that seems anti-climactic after yesterday’s CPI.  Add to that the Fed is coming and I cannot believe it will have any impact at all.

 

So, it is all about the Fed and how they sound since it seems pretty clear that they will not be adjusting rates today.  Look carefully at the dot plot as well, for clues to their forward-looking beliefs.  As to the dollar’s response, nothing has changed my big picture view that higher rates here will continue to support the greenback.

 

Good luck

Adf

Widened the Spread

Posted on by

Twixt ceilings for debt and the Fed

The market has widened the spread

Of rates here at home

Despite what Jerome

Last weekend ostensibly said

Thus, dollars remain to the fore

As traders want so many more

The megacaps rise

But in a surprise

There’s less and less talk of the war

The debt ceiling negotiations remain at the top of the market’s list of concerns as the ostensible X-date of June 1stapproaches.  Certainly, the positive aspect is that both sides are talking as opposed to merely grandstanding, but as is always the case in a political standoff with a non-political impact, it is clear no deal will be reached until the Nth hour.  The other thing to remember is that the June 1st date is not a hard deadline, it is the current estimate by Secretary Yellen and subject to change.  In the end, nothing has changed my view that a deal will be reached as both sides desperately want one, but also, no deal will be reached until both sides can explain to their supporters that they did everything possible to achieve their agendas.

However, this process is clearly having an impact on the markets, especially in the interest rate space as we have seen 10-year Treasury yields, which are higher today by 3.3bps, rise 36 basis points in the past two weeks.  In addition, the yield curve inversion, which at one point had fallen to as low as -41bps, is back to a -64bp difference.  Not only that, but the 4-week T-bill, the nearest expiry past the X-date, is now yielding 5.47%, far above Fed funds and the highest spot on the yield curve.  That is clearly a direct response to fears over a possible default.  My sense is this process will go on right through Memorial Day and US interest rates may well have further to rise between now and then.

But this begs the question, are US rates dragging up rates around the world?  I would argue the answer is yes.  Looking at European sovereigns, which have all seen yields rise by around 3bps-4bps today (Gilts are actually +8bps), they have all risen in concert with Treasury yields.  During the same time frame that Treasuries rose 36bps, Bunds are +28bps, OATS +25bps and Gilts +43bps.  Yet during that period, the dollar has gained more than 1% vs. both the euro and the pound (and all the other G10 currencies as well). 

Perhaps what we are seeing is a new safe haven asset being born, the US megacap tech stock.  The likes of Apple, Microsoft and Alphabet have seen steady strength, helping to drive the NASDAQ 100 Index up nearly 5% during this same two-week period.  In fact, a quick look at YTD performance in US equity markets shows that the Dow Jones Industrials are +0.4% YTD while the NASDAQ is up 21.5%.  In the past, there was a concept during bouts of USD strength that investors were buying dollars to buy Treasuries.  I think right now investors are buying dollars to buy Apple!  In fairness, one can see the premise as regardless of the debt ceiling outcome or timing, the belief that Apple (or Microsoft or Alphabet) shares will react to that news rather than their own positive stories generates no concerns.

Of course, those names are the exceptions to the rule as the bulk of the rest of the market has been under pressure recently on the back of all the catastrophic predictions if the debt ceiling isn’t raised and the US defaults on its debt.  This can be seen in the fact that the other major indices have seen almost no movement, just sideways trading, during the recent period in question.

Turning to the Fed, it appears that we are reaching an inflection point in the tightening process, or at least in the rate hiking cycle.  While prior to the last FOMC meeting, virtually every speaker was on the same message, we are starting to see some differences.  Most importantly, Powell, last weekend, hinted that there was some concern that the continued rate hikes were starting to impact financial stability (seriously, after 4 major bank failures it is now a concern?). But the implication is that while inflation remains job number one, there are other issues on the agenda.  That seems to be the dovishness that was attributed to Powell over the weekend.

Meanwhile, yesterday we heard from two regional Fed presidents.  James Bullard from St Louis, who said that he saw at least two more rate hikes (50bps total) as necessary to be certain they have slain the inflation dragon.  As per Bloomberg news, “I think we’re going to have to grind higher with the policy rate in order to put enough downward pressure on inflation and to return inflation to target in a timely manner,” Bullard said at an event in Florida on Monday.  “I’m thinking two more moves this year — exactly where those would be this year I don’t know — but I’ve often advocated sooner rather than later.”

However, we also heard from Minneapolis President Neel Kashkari with a different message, “I think right now it’s a close call, either way, versus raising another time in June or skipping.  What’s important to me is not signaling that we’re done.”  I guess the Eccles Building will be rocking in June when they next meet.

As it stands currently, at least according to the Fed funds futures market, the market is pricing in a 23% probability of a 25bp rate hike on June 14th.  Remember, though, between now and then we see a lot of critical data including this week’s Core PCE release, next week’s NFP data and finally the May CPI data, scheduled to be released the day before the FOMC announcement.  In the meantime, all eyes seem to be on the debt ceiling negotiations, and reasonably so, given the fallout could begin before the big data comes. 

Looking at today, the big movers overnight were the bond markets with equity markets mildly in the red in both Asia and Europe.  US futures are also edging lower, but barely -0.1% at this hour (7:45).  As to commodities, oil (+0.5%) is edging higher on word that the Saudis are going to push for another production cut, while gold (-0.5%) is sliding on the back of the strong dollar and the base metals are falling again, clearly anticipating a recession.

As to the dollar, it remains king of the hill, continuing to rally vs. virtually all its G10 counterparts with only the yen (+0.1%) managing to hold its own.  In the emerging market space, the story is similar with HUF (-1.0%) the laggard on expectations of a rate cut today and the bulk of the bloc lower.  The one outlier seems to be KRW (+0.4%) which saw substantial equity inflows as the driver.  I would be remiss if I didn’t mention that CNY has rallied substantially in my absence and is now well above 7.0500 as there is a growing belief the PBOC will continue to ease policy to support the Chinese economy.

On the data front today, we see preliminary PMI data (exp 50.0 Mfg, 52.5 Services) and New Home Sales (665K).  The European flash PMI data was slightly soft, but pretty close to expectations.  Meanwhile, only Dallas Fed President Lorie Logan is on the docket today, but don’t be surprised to hear from others on CNBC or BBG as they basically cannot shut up.

In the wake of the Silicon Valley Bank failure, I was convinced the Fed was going to be finished and accordingly, changed my views on the dollar.  I had been bullish until a clear pivot was seen and I thought that was the case.  However, it increasingly appears that no pivot is coming and that higher for longer is the future.  In that case, I have to revert to my original stance and look for continued dollar strength until we get that signal.

Good luck

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Ready to Pop

Posted on by

Investors are having some trouble
Determining if the stock bubble
Is ready to pop
Or if Jay will prop
It up, ere it all turns to rubble

So, volatile markets are here
Most likely the rest of this year
Then, add to this fact
A Russian attack
On Ukraine.  I’d forecast more fear

One has to be impressed with yesterday’s equity markets in the US, where the morning appeared to be Armageddon, while the afternoon evolved into euphoria.  Did anything actually change with respect to information during the day?  I would argue, no, there was nothing new of note.  The proximate cause of the stock market’s decline appeared to be fear over escalating tensions in the Ukraine.  Certainly, that has not changed.  Russia continues to mass troops on its border and is proceeding with live fire drills off the coast of Ireland.  The Pentagon issued an order for troops to be ready for rapid deployment, which Russia claimed was fanning the flames of this issue.  While the key protagonists continue to talk, as of yet, there has been no indication that a negotiated solution is imminent.  With that in mind, though, today’s market reactions indicate somewhat less concern over a kinetic war.  European equity markets are all nicely higher (DAX +0.6%, CAC +0.8%, FTSE 100 +0.75%) and NatGas in Europe (-2.4%) has retraced a bit of yesterday’s surge.  Granted, these reversals are only a fraction of yesterday’s movement, but at least markets are calmer this morning.

However, one day of calm is not nearly enough to claim that the worst is behind us.  And, of course, none of this even considers the FOMC meeting which begins this morning and from which we will learn the Fed’s latest views tomorrow afternoon.  The punditry is virtually unanimous in their view that the first Fed funds hike will come in March and there will be one each quarter thereafter.  In fact, if there are any outliers, they expect a faster pace of rate hikes with five or more this year as the Fed makes a more concerted effort to temper rising prices.

Now, we have not heard from a Fed speaker since January 13th, nearly two weeks ago, although at that time there was a growing consensus that tighter policy needed to come sooner and via both rate hikes and balance sheet reduction.  But let’s take a look at the data we have seen since then.  Retail Sales were awful, -1.9%; IP -0.1% and Capacity Utilization (76.5%) both disappointed as did the Michigan Sentiment indicator at 68.8, its lowest print since 2011.  While the housing market continues to perform well, Claims data was much higher than anticipated and the Chicago Fed Activity Index fell sharply to -0.15, where any negative reading is seen as a harbinger of future economic weakness.  Finally, the Atlanta Fed’s GDPNow indicator has fallen to 5.14%, down from nearly 10% in December.  The point is, the data story is not one of unadulterated growth, but rather of an economy that is struggling somewhat.  It is this issue that informs my decision that the Fed is likely to sound far more dovish than market expectations tomorrow,  The policy error that has been discussed by the punditry is the Fed tightening policy into an economic slowdown and exacerbating the situation.  I think they are keenly aware of this and will move far more slowly to tackle inflation, especially given their underlying view that inflation is going to return to its previous trend on its own once supply chains are rebuilt.

For now, barring live fire in Ukraine, it seems the market is quite likely to remain rangebound until we hear from Mr Powell tomorrow afternoon.  As such, it is reasonable to expect a bit less market volatility than we saw yesterday.  But, do not discount the fact that markets remain highly leveraged in all spaces and that the reduction of high leverage has been a key driver of every market correction in history.  Add that to the fact that a Fed that is tightening policy may push rates to a point where levered accounts are forced to respond, and you have the makings of increased market volatility going forward.  While greed remains a powerful emotion, nothing trumps fear as a driver of market activity.  Yesterday was just an inkling of how things may play out.  Keep that in mind as we go forward.

Touring the markets this morning, while Europe is bouncing from yesterday’s movement as mentioned above, Asia saw no respite with sharp declines across the board (Nikkei -1.7%, Hang Seng -1.7%, Shanghai -2.6%).  US futures, too, are under pressure at this hour with NASDAQ (-1.7%) leading the way, but the other main indices much lower as well.

Looking at bond markets, European sovereigns are all softer with yields backing up as risk is re-embraced (Bunds +2.1bps, OATs +1.4bps, Gilts +4.4bps) as are Treasury markets (+0.7bps), despite the weakness in equity futures.  Bond investors are having a hard time determining if they should respond to ongoing high inflation prints or risk reduction metrics.  In the end, I continue to believe the latter will be the driving force and yields will not rise very high despite rising inflation.  The Fed, and most central banks, are willing to live with rising prices if it means they can stabilize bond yields at relatively low levels.

In the commodity markets, oil (+0.1%), after falling sharply from its recent highs yesterday has rebounded slightly.  NatGas (-1.4%) in the US is also dipping although remains right around $4/mmBTU in the US and $30/mmBTU in Europe.  Gold (-0.25%) and Copper (-0.3%) continue to consolidate as prospects for weaker growth hamper gains of the latter while uncertainty over inflation continue to bedevil the former.

As to the dollar, it is stronger for a second day in a row today, with substantial gains against both G10 (NOK -0.7%, CHF -0.7%, SEK -0.6%) and EMG (PLN -0.75%, RON -0.5%, MXN -0.45%) currencies.  Clearly, the Ukraine situation remains a problem for those countries in proximity to the geography, while Mexico responds to slightly disappointing GDP growth data just released.  But in the end, the dollar remains the haven of choice during this crisis and is likely to remain well bid for now.  However, if, as I suspect, the Fed comes across as less hawkish tomorrow, look for the greenback to give up some of its recent gains.

This morning brings only second tier data; Case Shiller Home Prices (exp 18.0%) and Consumer Confidence (111.1).  So, odds are that the FX market will continue to take its cues from equities, and if the sell-off resumes in stocks, I would expect the dollar to remain firm.  For payables hedgers, consider taking advantage of this strong dollar as I foresee weakness in its future as the year progresses.

Good luck and stay safe
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Confidence Wilts

Posted on by

As central banks worldwide prepare
To raise rates investors don’t dare
Buy bonds, bunds or gilts
While confidence wilts
Defining Jay Powell’s nightmare

The upshot is negative rates
Are no longer apt for long dates
But we’re still a ways
From NIRP’s end of days
While Christine and friends have debates

Whatever else you thought mattered to markets (e.g. Russia/Ukraine, oil prices, omicron) you were wrong.  Right now, there is a single issue that has every pundit’s tongue wagging; the speed at which the Fed tightens policy.  Don’t get me wrong, oil’s impressive ongoing rally feeds into that discussion, but is clearly not the driver.  So too, omicron’s impact as it spreads rapidly, but seems clearly to be far less dangerous to the vast majority of people who contract the disease.  As to Russia and the widespread concerns that it will invade the Ukraine shortly, that would certainly have a short-term market impact, with risk appetite likely reduced, but it won’t have the staying power of the Fed tightening discussion.

So, coming full circle, let’s get back to the Fed.  The last official news we had was that tapering of asset purchases was due to end in March with the Fed funds rate beginning to rise sometime after that.  Based on the dot plot, expectations at the Eccles Building were for three 0.25% rate increases this year (Jun, Sep and Dec).  Finally, regarding the balance sheet, expectations were that process would begin at a modest level before the end of 2022 and its impact would be minimal, you remember, as exciting as watching paint dry.  However, while the cat’s away (Fed quiet period) the mice will play (punditry usurp the narrative).

As of this morning, the best I can figure is that current market expectations are something along the following lines: QE will still end in March but the first of at least four 0.25% rate hikes will occur at the March FOMC meeting as well.  In fact, at this point, the futures market is pricing in a 12.5% probability that the Fed will raise rates by 0.50% in March!  In addition, regarding the balance sheet, you may recall that in 2017, the last time the Fed tried to reduce the size of the balance sheet, they started at $10 billion/month and slowly expanded that to $50 billion/month right up until the stock market tanked and they reversed course.  This time, the punditry has interpreted Powell’s comments that the runoff will be happening more quickly than in 2017 as a starting point of between $40 billion and $50 billion per month and rising quickly to $100 billion/month as they strive to reach their target size, whatever that may be.

The arguments for this type of action are the economy is much stronger now than it was in 2017 and, more importantly, inflation is MUCH higher than it was in 2017, as well as the fact that the balance sheet is more than twice the size, so bigger steps are needed.  Now, don’t get me wrong, I am a strong proponent of the Fed disentangling itself as much as possible from the markets and economy, however, I can’t help but wonder if the Fed moves according to the evolving Street narrative, just how big an impact that will have on asset markets.  Consider that since the S&P 500 traded to its most recent high on January 4th, just 2 weeks ago, it has fallen 5.0%.  The NASDAQ 100 has fallen 10.5% from its pre-Thanksgiving high and 8.5% from its level on January 4th.  Ask yourself if you believe that Jay Powell will sit by and watch as a much deeper correction unfolds in equity markets.  I cannot help but feel that the narrative has run well ahead of reality, and that next week’s FOMC meeting is going to be significantly more dovish than currently considered.  We have seen quite substantial market movement in the past several weeks, and if there is one thing that we know for sure it is that central banks abhor sharp, quick movement in markets, whether higher (irrational exuberance anyone?) or lower (Powell pivot, “whatever it takes”.)

The argument for higher interest rates is clear with inflation around the world (ex Japan) soaring, but central bankers are unlikely, in my view, to tighten as rapidly as the market now seems to believe.  They simply cannot stand the pain and more importantly, fear the onset of a recession for which they will be blamed.  For now, though, this is the only story that matters, so we have another week of speculation until the FOMC reveals their latest moves.

Ok, so yesterday was a massive risk-off day, with equities getting clobbered while bonds sold off sharply on fears of central bank actions.  In fact, the only things that performed well were oil, which rose 2.7% (and another 1.5% this morning) and the dollar, which rallied against virtually all its G10 and EMG counterparts.  Overnight saw the Nikkei (-2.8%) follow in the footsteps of the US markets although the Hang Seng (+0.1%) and Shanghai (-0.3%) were far more sanguine.  Interestingly, European bourses are mostly green today (DAX +0.25%, CAC +0.55%, FTSE 100 +0.25%) despite further data showing inflation is showing no sign of abating either on the continent (German CPI 5.7%) or in the UK (CPI 5.4%, RPI 7.5%).  As to US futures, +0.2% describes them well at this hour.

Bond markets remain under severe pressure with yields higher everywhere except China and South Korea.  Treasuries (+1.4bps) continue their breakout and seem likely to trade to 2.0% sooner rather than later.  Bunds (+2.6bps and yielding +0.003%) have traded back to a positive yield for the first time since May 2019.  Of course, with inflation running at 5.7%, that seems small consolation.  OATs (+2.4bps) and the rest of the continental bonds are showing similar yield rises while Gilts (+5.2bps) are leading the way lower in price as investors respond to the higher than already high expectations for inflation this morning.  Remember, the BOE is tipped to raise the base rate as well next week, but the global impact will be far less than whatever the Fed does.

Oil prices continue to soar as the supply/demand situation continues to indicate insufficient supply for growing demand.  This morning, the IEA released an update showing they expect demand to grow by an additional 200K barrels/day in 2022 while OPEC+ members have been unable to meet their pumping quotas and are actually short by over 700K barrels/day.  I don’t believe it is a question of IF oil is going to trade back over $100/bbl, it is a question of HOW SOON.  Remember, with NatGas (-0.5% today) still incredibly expensive in Europe, utilities there are now substituting oil for gas as they try to generate electricity, adding more demand to the oil market.  And remember, none of this pricing includes the potential ramifications if Russia does invade the Ukraine and the pipelines that run through Ukraine get shut down.

Finally, the dollar is retracing some of yesterday’s substantial rally, falling against all its G10 brethren (NOK +0.45%, AUD +0.4%, CAD +0.3%) led by the commodity currencies, and falling against most of its EMG counterparts with RUB (+1.4%) and ZAR (+1.05%) leading the way.  The former is clearly benefitting from oil’s sharp rally, but also from rising interest rates there.  Meanwhile, a higher than expected CPI print in South Africa, (5.9%) has analysts calling for more rate hikes there this year and next with as much as 250bps expected now.

On the data front, yesterday saw a horrific Empire Manufacturing outcome (-0.7 vs. exp 25.0), clearly not a positive sign for the economic outlook.  This morning brings only Housing Starts (exp 1650K) and Building Permits (1703K), neither of which seem likely to move the needle.

With the Fed silent, the narrative continues to run amok (an interesting visual) but that is what is driving markets right now.  This is beginning to feel like an over reaction to the news we have seen, so I would be wary of expecting a continuation of yesterday’s risk-off sentiment.  While we will almost certainly see some more volatility before the FOMC announcements next week, it seems to me that we are likely to remain within recent trading ranges in the dollar rather than break out for now.

Good luck and stay safe
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Policy, Tighter

Posted on by

Apparently, seven percent
Defined for Chair Jay the extent
Of just how high prices
Can rise in this crisis
Ere hawkishness starts to foment

But is it too little too late?
As he’s not yet out of the gate
Toward, policy, tighter
Despite a speechwriter
That claims he won’t fail his mandate

There is no shame in being confused by the current market situation because, damn, it is really confusing!  On the one hand we see inflation not merely rising, but fairly streaking higher as yesterday’s 7.04% Y/Y CPI reading was the highest since June 1982.  With that as a backdrop, and harking back to our Economics 101 textbooks, arguably we would expect to see interest rates at much higher levels than we are currently experiencing.  After all, in its simplest form, real interest rates, which are what drive investment decisions, are simply the nominal interest rate less inflation. As of today, with effective Fed Funds at +0.08% and the 10-year Treasury at 1.75%, the calculated real interest rates are -6.96% in the front end and -5.29% in the 10-year, both of which are the lowest levels in the post WWII era.  The conclusion would be that investment should be climbing rapidly to take advantage.  Alas, most of the investment we have seen has been funneled into share repurchases rather than capacity expansion.

With this in mind, it makes sense that dollar priced assets are rising in value, so stocks and commodities would be expected to climb, as would the value of other currencies with respect to the dollar.  However, the confusion comes when looking at the bond market, where not only are real yields at historically depressed levels, but there is no indication that investors are selling bonds and seeking to exit the space.

Our economics textbook would have us believe that negative real yields of this magnitude are unsustainable with two possible pathways to adjustment.  The first pathway would be nominal yields climbing as investors would no longer be willing to hold paper with such a steep negative yield.  Back in the 1990’s, the term bond vigilantes was coined to describe how the bond market would not tolerate this type of activity and investors would sell bonds aggressively thus raising the cost of debt for the government.  So far, that has not been evident.  The second pathway is that the inflation would lead to significant demand destruction and ultimately a recession which would slow inflation and allow bondholders to get back to a positive real yield outcome.  Not only would that be hugely painful for the economy, it will take quite a while to complete.

The problem is, neither of those situations appear to be manifest.  The question of note is, is the bond market looking at the current situation and pricing in much slower growth ahead?  Certainly, the punditry is not looking for that type of outcome, but then, the punditry is often wrong.  Neither is the Fed looking for that type of outcome, at least not based on their latest economic projections which are looking for GDP growth of 3.6%-4.5% this year and 2.0%-2.5% next with nary a recession in sight in the long run.

This brings us back to the $64 trillion question, why aren’t bonds selling off more aggressively?  And the answer is…nobody really knows.  It is possible that investors are still willing to believe that this inflationary spike is temporary, and we will soon see CPI readings falling and the Fed declaring victory, so bond ownership remains logical.  It is also possible that given the fact that the BBB bill was pulled and seems unlikely to pass into legislation, that Treasury issuance this year will decline such that the fact the Fed will no longer be purchasing new debt will not upset the supply/demand balance and upward pressure on yields will remain absent.  At least from a supply perspective.  The problem with this idea is that pesky inflation reading, which, not only remains at extremely high levels, but is unlikely to decline very much at all going forward.

Ultimately, something seems amiss in the bond market which is disconcerting as bond investors are typically the segment that pays closest attention to the reality on the ground.  While the hawkish cries from Fed members are increasing in number and tone (just yesterday both Harker and Daly said they expected raising rates in March made sense and 4 rate hikes this year would be appropriate), that implies Fed Funds will be 1.0% at the end of the year, still far below inflation and not nearly sufficient to slow those rising prices.

It seems to me there are three possible outcomes here; 1) bond investors get wise and sell long-dated Treasuries steepening the yield curve significantly; 2) the Fed gets far more aggressive, raising rates more than 100 basis points this year and pushes to invert the yield curve and drive a recession; or 3) as option 1) starts to play out, and both stocks and bonds start to decline sharply, the Fed decides that YCC is the proper course of action and caps Treasury yields while letting inflation run much hotter.  My greatest fear is that 3) is the answer at which they will arrive.

With all that cheeriness to consider, let’s look at how markets are behaving today.  Despite a modest equity rally in the US yesterday, risk has been less in demand since.  Asia (Nikkei -1.0%, Shanghai -1.2%, Hang Seng +0.1%) was generally lower and Europe (DAX 0.0%, CAC -0.5%, FTSE 100 -0.1%) is also uninspiring.  There has been virtually no data in either time zone, so this price action is likely based on growing concerns over the inflationary outlook.  US futures at this hour are basically unchanged.

As to the bond market, no major market has seen a move of even 0.5 basis points today with inflation concerns seeming to balance risk mitigation for now.

Commodity markets are mixed with oil (-0.1%) edging lower albeit still at its highest levels since 2014, while NatGas (-4.5%) has fallen as temperatures in the NorthEast have reverted back to seasonal norms.  Gold (-0.1%) has held most of its recent gains while copper (-0.7%) seems to have found a short-term ceiling after a nice rally over the past few sessions.

Finally, turning to the dollar, it is somewhat softer vs. most of its G10 brethren with NZD (+0.35%) leading the way, followed by CHF (+0.3%) and CAD (+0.2%) as demand for any other currency than the dollar begins to show up.  In EMG currencies, excluding TRY (-2.5%) which remains in its own policy driven world, the picture is more mixed.  RUB (-0.75%) has fallen in the wake of the news from Geneva that there was no progress between Russia, the US and NATO regarding the escalating situation in the Ukraine with the threat of economic sanctions growing.  BRL (-0.55%) is also under some pressure although this looks more like profit taking after a nearly 3% rally in the past two sessions.  On the plus side, THB (+0.5%) and PHP (+0.3%) are leading the way as they respond to the broadly weaker dollar sentiment.

Data today brings Initial (exp 200K) and Continuing (1733K) Claims as well as PPI (9.8%, 8.0% ex food & energy), but the latter would have to be much higher than expected to increase the pressure on the inflation narrative at this point. From the Fed we hear from Governor Brainerd as she testifies in her vice-chair nomination hearing, as well as from Barkin and Evans.  Given the commentary we have been getting, I expect that the idea of 4 rate hikes this year is really going to be cemented.

The dollar has really underperformed lately and quite frankly, it feels like it is getting overdone for now.  While I had always looked for the dollar to eventually decline this year, I did expect strength in Q1 at least.  However, given positioning seemed to be overloaded dollar longs, and with the Treasury market not participating in terms of driving yields higher, it is beginning to feel like a modest correction higher in the dollar is viable, but that the downtrend has begun.

Good luck and stay safe
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