Tag Archives: #Powell

Lately Downturned

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The story is still ‘bout the Fed
And whether, when looking ahead
They see skies are blue
And so, they eschew
A rate cut the bears will all dread
 
But if they are growing concerned
The ‘conomy’s lately downturned
Then fifty will be
What we all will see
And bears, once again, will be spurned

 

As we move closer to the FOMC announcement and Powell press conference, the nature of the discussion has focused entirely on the size of the rate cut that will be announced tomorrow.  Yet again this morning, the Fed whisperer, Nick Timiraos at the WSJ, published an article on the subject, once again making the case for 50 basis points.  The money quote is below:

“Fed officials aren’t likely to regret a larger rate cut this week if the economy chugs along between now and their next meeting, in early November, because rates will still be at a relatively high level, he said. But if the Fed makes a smaller move and the labor market deteriorates more rapidly, officials will feel greater regret.”

As well, the futures market is growing more and more certain 50bps is coming as evidenced by the pricing this morning as per the below chart from the CME:

The interesting thing is that an unbiased (if such a thing exists) look at the data does not scream out to me that the economy is collapsing such that an aggressive start to an easing cycle is necessary.  Unemployment remains in the lowest quintile of outcomes over the past 76 years.  For reference, the median reading since January 1948 has been 5.5%, the average has been 5.7% and today it is at 4.2%.  The chart below shows the distribution of outcomes over the entire data series from the FRED database.

Data source: FRED database; calculation: fx_poetry.com

It is difficult to look at this chart and think the economy is imploding.  And let us consider another thing, the widely mentioned long and variable lags by which monetary policy impacts the economy.  Whatever the Fed does tomorrow, the impact on almost the entire economy will not be felt for at least a year, if not much longer than that.  After all, do companies really make a borrowing decision based on the marginal 25bps of interest cost per annum?  I would argue that most corporate borrowing is based entirely on their current schedule of maturing debt and any forecast needs for capex or other funding.  It strikes me that whether the Fed funds rate is 5.25% or 5.00% is not going to change much in the real economy.

Markets, of course, are a different kettle of fish in this discussion, but let’s face it, the bond market has already priced in 250 basis points of cuts in the next twelve months, so whether they start with 25 or 50 seems less relevant than the destination.  Certainly, the equity market will try to goose things on a 50bp cut, and will almost certainly fall if the cut is only 25bps, at least initially, but again, will corporate profits change that much in the short-run because of this move?

In the end, I fear we make far too much of the outcome, at least in this case.  Now, if Powell and the Fed were to decide that the recent call for a 75bp cut by three senators was an eloquent argument and did that, the market surprise would be substantial and the initial move in risky assets would be higher.  But something like that would also engender fears that the Fed knows something bad about the economy that the rest of us have missed, and that would result in its own negative consequences. I guess the good news is we only have another 30 hours or so before we find out.

As to the market activity overnight, yesterday’s mixed US equity performance, with the DJIA making new all-time highs while the NASDAQ fell -0.5%, led to weakness in Tokyo (Nikkei -1.0%) as tech shares underperformed, but strength in HK (+1.4%) and much of the rest of Asia that was open.  Both China and South Korea remained closed for holidays.  In Europe, though, given the virtual lack of technology shares available, the DJIA was the template with all markets higher this morning led by Spain’s IBEX (+1.25%)), but with robust gains elsewhere on the order of +0.6% to +0.8%.  As to US futures, at this hour (7:30), they are higher by about 0.25%.

In the bond market, yields continue to edge lower overall.  While Treasuries are unchanged this morning, that follows another 2bp decline yesterday afternoon.  In Europe this morning, sovereign yields are all lower by between -1bp and -3bps, catching up (down?) to the Treasury market as well as responding to pretty awful German ZEW numbers (Sentiment 3.6 vs. 17.0 expected and 19.2 last month; Current Conditions -84.5 vs. -80.0 expected and -77.3 last month).  Germany remains the sick man of Europe and there is no doubt that they need to see the ECB start to cut rates more aggressively to help support their withering manufacturing sector.  And one more thing, JGB yields fell -2bps last night and are now at 0.81% in the 10yr.  While the focus will turn to the BOJ at the end of the week after the FOMC announcement tomorrow, the market does not appear to be particularly concerned over aggressive tightening there.

In the commodity markets, WTI (+0.15%) has crept back above $70/bbl for the first time in nearly two weeks as the big story in the market revolves around the net speculative Comex positioning which has turned negative for the first time ever.  That means that hedge funds and speculators are net short oil futures.  While they may have a negative outlook, the positioning does indicate there is an opportunity for a massive short-squeeze sometime going forward.  As to the metals markets, they are little changed this morning, broadly holding their recent gains with both precious and industrial metals all showing healthy gains in the past week.  A 50bp cut should support prices across the board here.

Finally, the dollar is softer again this morning, but by a modest amount, about -0.1% across the board.  Those are the types of gains we have seen across the G10 and most of the EMG currencies with one outlier, MXN (-0.9%).  However, the peso, which had strengthened nearly one full peso in the past four trading sessions looks more like it is responding to that movement than to any fundamental changes.  The judicial review story is now old news although there may be some concerns that Banxico will cut more aggressively next week if the Fed does so tomorrow.

On the data front, this morning brings Retail Sales (exp -0.2%, ex autos +0.2%) as well as IP (0.2%) and Capacity Utilization (77.9%).  We also hear from Dallas Fed president Logan this morning.  It’s funny, a strong Retail Sales number could well weigh on the chances for a 50bp cut as further evidence that things continue to be moving along fine.  Remember, even though inflation has been trending lower, it is not yet nearly at its target.  Retail Sales strength would indicate that employment remains robust as people spend money more readily when they have a paycheck, so the need for more stimulus may just not be that critical.

In the end, my best take is the Fed is going to cut 50bps tomorrow and the market is going to increasingly price that in as the session unfolds.  This will be especially true if Retail Sales is weaker than forecast, but even if it surprises on the upside, I remain convinced Powell wants to cut 50bps based on the number of articles discussing the idea in the mainstream press.  Ultimately, I think the dollar will suffer a bit further on that move and commodities will be the big winners.

Good luck

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Powell’s Dream Team

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The punditry’s dominant theme
Is whether Chair Powell’s dream team
Will cut twenty-five
And try to contrive
A reason a half’s a pipe dream
 
But there’s something getting no press
The balance sheet shrinking process
They’re still in QT
But what if QE
Is something they’ll now reassess?

 

With all the data of note now passed (PPI was largely in line although tending a bit higher than forecast) and the ECB having cut their deposit facility rate by 25bps, as widely expected, the market discussion is now on whether the Fed will cut by one-quarter or one-half percent next week.  The Fed funds futures market, which you may recall had been pricing as little as a 15% probability for that 50bp cut earlier this week, is currently a coin toss between the two outcomes.  In addition, the Fed whisperer, Nick Timiraos of the WSJ, had a front page article on the subject this morning, although he drew no conclusions.

But something that is getting virtually no airtime is the Fed’s balance sheet and its ongoing shrinkage.  You may recall that the current level of QT is $25 billion/month, which was reduced from the original amount of $60 billion/month back in June as the FOMC started to grow cautious regarding the appropriate amount of reserves and liquidity in the system.  

The issue is nobody knows what number constitutes the right amount of reserves.  Fed research is of the belief that somewhere between 10% and 12% of GDP (currently about $2.7 trillion to $3.3 trillion) should be sufficient to ensure that economic activity does not grind lower due to a lack of liquidity.  This has been the rationale behind the slow reduction in balance sheet assets.  But that research may not be accurate, and the underlying assumption was that the economy continued to grow at its trend rate.  In the event of a slowdown or recession, you can be sure that the Fed will add liquidity back as well as cut rates.

Now, working against my thesis is the Fed has not discussed this idea at all, at least publicly, and so a complete surprise is not their typical MO.  However, they have found themselves in a place where the market is pricing in more than 100 basis points of cuts over the next three meetings, including next week’s, which if they stick to their 25bp increments, means that one of these meetings needs a 50bp cut.  As I have written before, the bond market is pricing nearly 200bps of cuts in the next two years (see chart below), which would indicate that the likelihood of an economic slowdown is high.  

Source: tradingeconomics.com

At the same time, equity markets are trading near all-time highs with earnings estimates indicating that economic growth expectations remain quite robust.  Both of those scenarios cannot be true at the same time.

Source: LSEG

This is the landscape through which Chairman Powell must navigate the Fed’s policies as well as his communication of those policies.  In Jackson Hole, he virtually promised a rate cut was coming next week, and one is certainly on its way.  The magnitude of that cut, though, will offer the best clues as to the Fed’s thinking with respect to the future trajectory of the economy and which market, stocks or bonds, is right. 

There is one other thing to consider, though, as an investor. Given the bond market is pricing a significant slowdown, if that is your view, bonds will not offer much return if you are correct.  And if you are wrong, and growth is strong, it will be ugly.  Similarly, if you are of the view that there is no recession, but rather a soft- or no-landing is the likely outcome, then being long stocks, which have already priced for that outcome will likely have only a modest benefit.  However, in the event that the economy does fold and recession arrives, stocks are likely to sell-off sharply.  Arguably, the best positioning for a trader is to be short both stocks and bonds, as whichever outcome prevails, one asset will fall substantially while the other has limited upside, at least for a while.  For a hedger, this is the time that options make a lot of sense as the asymmetry they provide is what allows a hedger to prevent locking in the worst outcomes.

Ok, with that behind us, let’s look at the overnight session to see how things followed yesterday’s risk rally in the US.  In Asia, the Nikkei (-0.7%) has been struggling lately on the back of continued JPY strength.  As you can see from the below chart, that relationship has been pretty strong for a while, and last night, USDJPY traded to new lows for the year, erasing the entire gain (yen decline) that peaked at the end of June.

Source: tradingeconomics.com

As to the rest of Asia, mainland Chinese shares (CSI 300 -0.4%) continue to underperform although HK shares managed a rally (+0.75%) while most of the rest of the region showed very modest strength, certainly nothing like the US performance, but at least in the green.  In Europe, equity markets are all higher this morning with Spain’s IBEX (+0.8%) leading the way although solid gains of 0.3% – 0.5% prevalent elsewhere.  As to US futures, at this hour (7:45) they are creeping higher by about 0.1%.

In the bond market, Treasury yields are lower by 2bps this morning and European sovereign yields are generally little changed to lower by 2bps across the continent.  Yesterday’s ECB outcome was universally expected, and Madame Lagarde explained they remain data dependent and promised no timeline for potential further rate cuts, if they are even to come (they will).  As to JGB yields, they too fell 2bps last night, once again confusing those who are looking for policy tightening in Tokyo.

In the commodity markets, oil (+1.4%) is rallying for the third consecutive day as Hurricane Francine shut in about 40% of gulf production and the timing of its return is still uncertain.  Despite the US equity markets’ clear economic bullishness, the weak growth/demand story is still a major part of this discussion.  In the metals markets, gold (+0.3% overnight, +3.2% in the past week) continues to set new price records daily with a story making the rounds that SAMA, Saudi Arabia’s central bank, secretly bought 160 tons of gold last quarter, soaking up much supply.  This has helped drag silver back above $30/oz although copper (-0.5%) is stumbling a bit this morning.

Finally, it should be no surprise that the dollar is under some pressure this morning as the talk of more aggressive Fed easing grows.  While the euro and pound are little changed, JPY (+0.5%) is leading the way in the G10 with AUD (+0.45%), NZD (+0.4%), NOK (+0.2%) and SEK (+0.3%) all firmer on the back of commodity strength.  In the EMG bloc, the story is a bit more nuanced with ZAR (-0.15%) bucking the trend on domestic political concerns, although we saw strength in KRW (+0.5%) overnight and MXN (+0.35%) as the Fed rate cut story plays out across most currencies.

On the data front, only Michigan Sentiment (exp 68.0) is on the docket so once again, the dollar will be subject to the equity market behavior and the strength of narrative regarding just how dovish the Fed will wind up behaving next week.  I will say that a 50bp cut is likely to see some short-term dollar weakness, probably enough for it to fall to multi-year lows vs. its major counterparts.  But remember, if the Fed starts getting aggressive, other central banks will feel comfortable following that lead, so the dollar’s weakness may not be that long-lived.

Good luck and good weekend

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A New Pox

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The interest rate doves are excited
That job growth in August was blighted
If that was the case
The Fed may embrace
Enough cuts to leave them delighted
 
But if they’re correct, what of stocks?
Will weak data be a new pox
On earnings and growth
And undermine both
With stocks falling onto the rocks?

 

As far as anyone can tell, there is only one thing that matters today, the payroll report.  Let’s set the table with the latest median forecasts:

Nonfarm Payrolls160K
Private Payrolls139K
Manufacturing Payrolls0K
Unemployment Rate4.2%
Average Hourly Earnings 0.3% (3.7% Y/Y)
Average Weekly Hours34.3
Participation Rate62.6%

Source: tradingeconomics.com

I’m sure you all remember that last month we got a surprising, and disappointing, reading of 114K for the headline number and then we subsequently got those massive revisions from the BLS which indicated that they had overstated job growth by more than 800K over the year from April 2023 through March 2024.  As well, yesterday’s ADP Employment data showed private job growth of a below expectations 99K with a revision lower to the previous month’s number.  Certainly, some of the data we have seen is pointing in the direction of a weaker outcome.  However, if one looks at the Initial and Continuing Claims data, neither of those series are pointing to a significant weakening in the labor market, although it has cooled somewhat since last year.

Since the last NFP report, 10-year Treasury yields have declined by 28bps and now sit at 3.70% this morning.  If you compare that to the current Fed funds rate of 5.375%, the implication is that rates are going to fall by at least 160 basis points over the next two years.  In fact, we are starting to see some analysts (Citi) call for nearly that many cuts by the end of 2024!  It strikes me that 150bps of cuts by December 2024 would only occur in response to a significant slowing of US economic activity, in other words, the long-awaited recession. Now, if the Fed were to cut that aggressively without a clear decline in the economy, it would certainly open the door to much higher inflation ahead.  After all, why add liquidity and ease policy if the economy continues to cruise along at a decent clip?

The upshot is that it appears, at least to this poet’s eyes, that the bond market is way ahead of itself with respect to potential Fed rate cuts.  Either that or the stock market is completely mispriced for the potential future earnings results of its components.  The one consistent outcome from all recessions is that corporate earnings growth slows dramatically.  Given that current equity prices embody P/E multiples near historically high levels (see chart below of Cyclically Adjusted Price Earnings for the S&P 500), if the E in that fraction declines, you better believe that so will the P.

Source: lesswrong.com

What will this mean for other asset classes, notably commodities and the dollar?  Here we need to consider the driver of the potential rate cuts in question.  If the US economy is clearly slowing dramatically and the Fed is responding by cutting rates aggressively, I would expect that the dollar will come under real pressure, at least initially, as the Fed is likely to be more aggressive than other central banks.  However, remember that the market is already pricing in significant rate cuts, so given the reality that if the US enters recession, most of the rest of the world is going to see much slower economic growth with their central banks easing policy as well, I would not look for a dollar decline of historic proportions.  Another 5%-8% seems viable but looking for the euro at 1.50 or the pound at 1.75 or the renminbi at 6.00 seems unrealistic.  The one outlier here is the yen, of course, where a situation with declining US equity prices, and correspondingly declining risk asset prices all over the world, could easily see Japanese investors run home with their money and USDJPY could well fall back to the 120 level or even lower in that scenario.

As to commodity prices, I expect the initial move would be lower as concerns about growth would imply falling demand for the key commodities oil and copper.  Gold, however, is a different animal and I imagine that we could see more uptake here as a weaker dollar and growing fear drive more retail buying of the barbarous relic.

Of course, if the data this morning is firmer than expected, all these bets are off.  In fact, that appears to be the biggest risk in markets today, a strong NFP number with a decline in the Unemployment Rate.  Market participants seem quite confident that the slowdown is coming and that the Fed is going to stick the soft landing.  That is the only explanation for the fact that equity markets, despite yesterday’s modest declines, continue to trade near all-time highs regardless of the indications that US economic activity is slowing somewhat.  The belief seems to be that the Fed will be able to cut rates the appropriate amount to prevent a collapse without triggering a renewed burst in inflation.  And maybe they will.  But given the fact that equity ownership is at record high levels already, the question becomes who is going to buy from here.  Any misstep by the Fed, where it becomes clear that the outcome will be worse than a soft landing (either a recession or higher inflation or both) is going to weigh heavily on equity and other risk markets.

So, as we await the big news, a quick review of the overnight session shows that most equity markets in Asia (Nikkei -0.7%, CSI 300 -0.8%) and Europe (DAX -0.4%, FTSE 100 -0.3%) are lower, following the US session.

In the bond markets, yields everywhere continue to decline with Treasury yields (-3bps) continuing their fall while European sovereign yields are all softer by between -4bps and -5bps this morning.  Even JGB yields (-3bps) are continuing lower as the global bond markets seem to be implying that economic activity is waning everywhere.

In the commodity markets, oil (+0.5%) is a touch firmer but remains below $70/bbl and has not shown any real strength despite a dramatic inventory drawdown reported by the EIA yesterday.  OPEC+ has explained they are not going to restart production next month and will wait until at least December before doing so, but based on the price action of oil, I will wager they will delay it again then.  Metals markets are little changed this morning after rallying yesterday during the US session, but like almost every market, all eyes are on the tape at 8:30 when NFP is released.

Finally, the dollar is a touch softer net, with traders seemingly preparing for a weak number.  But the movements are so small that the largest is JPY (+0.25%) which is the result of a combination of fear and the broader dollar weakness I think.    Here, too, we will learn much based on the data, so not much to do until then.

In addition to the payroll report we will hear from NY Fed President Williams and Governor Waller this morning as they will be the last to speak ahead of the Fed’s quiet period.  Williams is due at 8:45, so his speech is prepared, but Waller will have time to alter things if the data is a significant surprise given he doesn’t speak until 11:00.

And that’s really it for today.  It’s all NFP all the time.  While it is very easy to believe that a weak number is coming, it is also clear to me that the pain trade would be a strong number.  As such, I have a sneaking suspicion we could see something much firmer than forecast, maybe 200K with the Unemployment Rate ticking back down to 4.1%.  That would be the real surprise.

Good luck and good weekend

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JOLTed

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The market, on Wednesday, was JOLTed
By data, and traders revolted
The jobs situation
Has changed the narration
And helped Jay, his door be unbolted

 

What door you may ask?  Why, the door that leads to a 50bp rate cut at the FOMC meeting in two weeks.  Already, the Fed funds futures market is pricing in a 43% probability of a 50bp cut, up from a one-third probability on Tuesday morning.  Remember, everything now revolves around the labor market, and yesterday’s JOLTs data was not only worse than forecast, at 7.67M (forecast 8.1M), but last month’s was revised lower by nearly 200K jobs as well.  Remember, too, that tomorrow the NFP report is released with current forecasts centering on 160K, higher than last month but well down on what we have been seeing all year prior to the August report.

There are many analysts who have been calling out Powell and the Fed for making a policy error and holding rates too high for too long.  Perhaps they are correct.  But so much of the decision to cut rates relies on the idea that inflation is well and truly dead, or at least terminal, and if that assumption is incorrect, there will be hell to pay.  The last time the US saw inflation of the same magnitude that we have seen in the past two years, then Fed Chair, Arthur Burns, cut rates too early and inflation exploded higher, peaking at a higher rate than the first rise.  In fact, he did that twice, with inflation spiking three times throughout the 1970’s and early 1980’s.  

Source: FRED database

Powell has been very clear that he is trying to channel Paul Volcker and not Arthur Burns, but if he cuts rates, he opens himself up to a much less satisfactory outcome.  There have been many charts of the following nature showing the parallels of the 1970’s to recent price levels and it is entirely possible we see another wave higher if the Fed cuts.

Source: Real Investment Advice

As things currently stand, I would contend that the Fed’s focus is almost entirely on employment, hence the market response to yesterday’s weaker than forecast JOLTs data.  This implies that this morning’s ADP and Initial Claims data have the chance to really move things.  It also means that tomorrow’s NFP data remains a critical focus for all markets.

In the meantime, market activity overall could well be described as choppy.  While US equity markets opened lower yesterday, following the sharp declines on Tuesday, they closed mixed with limited overall movement. The fears in the semiconductor sector, which were fanned by a, since denied, report that Nvidia had been subpoenaed in an anti-trust investigation, has stopped falling and there are still numerous stories about how much Capex the big 4 tech companies are going to invest this year in all things AI.  Traders and investors are looking for the next big clue which is why I expect limited activity until tomorrow morning’s data release.

Asian equity markets were similarly mixed overnight with some gainers (Australia +0.4%, Taiwan +0.45%, CSI 300 +0.2%) and some laggards (Nikkei -1.05%, KOSPI -0.2%, Hang Seng -0.1%), as no clear direction presently exists.  Late last week, BOJ Governor Ueda sent a letter to the Diet explaining he still expected to raise interest rates if the economy progressed as expected, and that has a number of analysts calling for another leg down in USDJPY and further Nikkei weakness.  But it seems that is a big IF.  With economic activity clearly slowing around the world, it is not hard to believe that the same will be true in Japan and conditions for further rate hikes may not develop.  As to European bourses, the picture here is mixed as well with the CAC (-0.5%) lagging while Spain’s IBEX (+0.7%) is having a pretty good day.  Both the DAX (+0.2%) and FTSE 100 (+0.1%) are modestly higher despite weak Construction PMI data, perhaps both anticipating further policy ease.

In the bond markets, though, the direction of travel is clear for now with yields everywhere having fallen sharply yesterday and simply consolidating today.  After the JOLTs data, Treasury yields fell 9bps (2yr yields fell 12bps and the 2yr-10yr spread is now flat), although this morning it has bounced by a single basis point.  European sovereign yields slipped yesterday as well, between -3bps and -5bps, after the JOLTs data and this morning have backed up by 1bp across the board.  As to JGB yields, they edged lower by -1bp last night and remain a good distance from the 1.00% level despite the recirculated Ueda comments.

In the commodity markets, oil (+0.2%) which had bounced a bit yesterday morning, ceded those gains as the session wore on and is currently below $70/bbl.  While talk of OPEC+ starting up more production has faded, the weak economy / slowing demand story, especially the weak Chinese economy story, remains front and center and continues to weigh on the price.  Meanwhile, in the metals markets, gold (+0.7%) continues to shine overall as the growing sentiment for a 50bp Fed funds cut helps all commodities, but especially this one as concerns over the dollar’s ability to maintain its purchasing power remain rife.  But this morning we are seeing silver (+1.4%) and copper (+0.2%) higher as well, although the latter seem more trading than fundamentally based.

Finally, the dollar is under some modest pressure this morning, which given the movement in yields and rate cut expectations, should be no surprise.  In the G10, virtually all the movement has been less than 0.2% with CAD (-0.1%) the laggard after the BOC cut rates by 25bps yesterday as widely expected.  This morning the yen is also a touch softer, but that is after a sharp rally yesterday of more than 1%, so this morning feels like a trading bounce.  In the EMG bloc, the picture is a bit more mixed with ZAR (+0.5%) the leader this morning on both the gold price as well as economic data showing the Current Account deficit shrank dramatically in Q2 in a pleasant surprise.  On the flipside, MXN (-0.3%) is lagging as the market absorbs recent modestly weaker than expected economic data on Unemployment and Fixed Investment.

Which brings us to today’s data releases.  We start with ADP Employment (exp 145K), then Initial (229K) and Continuing (1870K) Claims.  As well, at 8:30 we see Nonfarm Productivity (2.4%) and Unit Labor Costs (0.8%).  Then, at 10:00 comes ISM Services (51.1) with the final set of data the EIA oil inventories at 11:00 with net further drawdowns forecast.  There are no Fed speakers on the docket today, but we are supposed to hear from two tomorrow after the NFP data.

Absent a big surprise in either ADP or Initial Claims, with the former more likely than the latter, I suspect that it will be another choppy day as all eyes focus on NFP tomorrow.  However, the one thing that seems likely is the dollar has further to decline within the current market narrative of more rate cuts sooner by Powell and the Fed.

Good luck

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Still Weak

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In Germany, data’s still weak
For Europe, that doesn’t, well, speak
So, riddle me this
Are traders remiss
For claiming that euros are chic?
 
It’s true interest rates matter most
And Powell said Fed funds are toast
But can M. Lagarde
Just simply discard
The Germans, though they’re comatose?

 

There is a growing opinion that the dollar is going to decline sharply as the Fed begins to cut rates.  Numerous analysts believe that the market is underpricing how many Fed fund cuts are coming as they are all-in on the US recession story.  After Friday’s Jackson Hole speech, it certainly appears that we will get at least one cut come September, but stranger things have happened.  And obviously, given Powell’s pivot from inflation to unemployment as job #1, the NFP report a week from Friday is going to be crucial.

But we must never forget that the FX market is a relative concept.  It is not simply that one country’s economy is doing well or poorly, nor that their interest rates are high or low, or perhaps moving up or down, it is how those data points compare to other countries that determines the movement in the FX markets, at least the fundamentals, but also frequently the capital flows.  It is with this in mind that on a quiet day we have time to dissect the story in Germany for a bit.  Early this morning, Germany’s Federal Statistical Office released two data points, the GfK Consumer Confidence reading, which fell sharply to a below consensus reading of -22.0 and the Final GDP Growth numbers for Q2, which printed at -0.1% Q/Q and 0.0% Y/Y.  Now, this is not a single quarter feature in Germany as is illustrated in the below chart.

A graph with blue and yellow squares Description automatically generated

Source: tradingeconomics.com

In fact, GDP growth in Germany has averaged just 0.3% annually over the past 5 years, a pretty anemic level, and one that bodes ill for Europe as a whole.  Recall, Germany’s economy is the largest in Europe (and 3rdlargest in the world) and represents about 28.6% of the Eurozone’s total economy.  If the largest economy in a group of nations is stagnating, it is very difficult for the group’s overall growth rate to expand.  Compare that to the fact that the data to date in the US indicate that growth remains fairly solid (GDP +2.8% in Q2), and then ask yourself, where are the opportunities for activity more prevalent, Europe or the US?  Again, the macro picture seems to point to the US as a continued preferred destination for capital.

And yet, the euro is pushing back to its highest level since a brief spike in July 2023, and otherwise, early 2022 prior to that.  So, does it really make sense for the euro to continue to rally from here?  Literally, the only argument in its favor is that the Fed has now committed to begin easing policy and the market is pricing in about 200bps of rate cuts through the end of 2025.  Meanwhile, although the ECB has implemented their first rate cut, and seem set to execute their second next month, the market is only pricing in 125bps of cuts by December 2025, and just 50bps total for 2024, compared to 100bps for the Fed.

As such, here is the explanation for the euro’s recent solid performance.  But I believe the question to ask is, can this last?  If Germany’s economy is going to continue to bounce along at essentially zero growth, and there is nothing indicating a rebound is coming soon, it seems more likely to me that the rest of Europe follows it lower, rather than ignores Germany and powers ahead.  It’s not that individual small nations in the Eurozone won’t grow more quickly, but Germany’s position in the Eurozone, notably as a trade partner, implies that things are more likely to sag than soar.  

Yes, the euro has rebounded lately, but that has been in response to the interest rate pricing described above.  I think it is a fair bet that Madame Lagarde, when faced with a Eurozone that is growing more slowly than desired, is likely to accelerate interest rate cuts there.  And when that happens, the euro’s recent rise will very likely retrace.  I am not saying that the dollar is going to climb against everything, just that the euro’s strength feels suspect.  One poet’s view.

I’m sorry for the focus on Germany, but some days, there is very little macro news of note, and this seemed the most important, especially given that the idea of a much weaker dollar going forward is gaining traction.  

Ok, with that in mind, let’s look at the overnight activity, which was not all that substantial.  After yesterday’s split between tech shares (NASDAQ -0.85%) and industrials (DJIA +0.16% and a new ATH), Asian shares were mixed as well.  The Nikkei (+0.5%) had a solid session as did the Hang Seng (+0.4%) although mainland Chinese shares (-0.6%) continue to suffer, last night due to a much weaker than forecast earnings result from the parent company of Temu.  Of more concern than the result was the commentary by their CEO that prospects for consumption were dimming.  In Europe, there are some very modest gains, with the DAX (+0.2%) surprisingly holding up well, although the move is obviously quite minimal.  I cannot look at the Eurozone economy and expect anything other than more aggressive rate cuts from the ECB going forward.  As to US futures, at this hour (7:30), they are essentially flat.

In the bond market, yields are backing up from their recent lows with Treasuries higher by 3bps and European sovereigns by between 5bps and 7bps.  In fact, the real outlier is the UK gilt market where 10yr yields are higher by 9bps as there is an increasing concern that the Starmer government is going to blow up the budget there as the PM tries to implement his new policies.  You may remember what happened when Liz Truss was PM and proposed a high spending, high deficit budget and caused all kinds of havoc in the gilt market back in October 2022.  I would not rule out another situation like that quite frankly.  Finally, JGB yields edged lower by 1bp last night, continuing to prove that normal monetary policy in Japan remains a distant prospect.

In the commodity markets, oil (-0.4%) which is higher by > 5% in the past week, has stopped climbing for now.  Perhaps the fact that there have been no new military incursions in the Middle East has been sufficient to get the algos to start selling again on the poor demand story.  Gold (-0.2%) is also biding its time, as are the other metals, although all are retaining the bulk of their recent gains.  Generically, my dollar view is that it will weaken vs. stuff like commodities, not necessarily vs. other currencies.  Of course, this implies a rebound in inflation, something which I continue to see going forward.

Lastly, the dollar is little changed this morning, with most G10 and EMG currencies +/-0.2% or less compared to yesterday’s closing levels.  The biggest mover today is NZD (+0.4%), although I am hard-pressed to see any fundamental reason as there was neither data nor central bank commentary.  Arguably, this is the result of some position changes rather than a fundamental move.  And after that, nothing has moved much at all.

Yesterday’s Durable Goods print of +9.9% was astonishingly high, although the ex-transport reading of -0.2% was a tick lower than forecast.  I guess Boeing sold more planes than anticipated.  As to this morning, we see Case-Shiller Home Prices (exp 6.0%) and Consumer Confidence (100.7), neither of which seems likely to have a major impact.  SF Fed president Daly reiterated the Powell idea that the time has come to cut rates, and I expect every Fed speaker going forward up to the quiet period to say the same.  I guess the real problem will be if the NFP report is hot.  Right now, the early forecasts are for 100K NFP and the Unemployment Rate to remain unchanged at 4.3%.  But what if it prints at 200K and Unemployment slips back a tick?  Will they still be anxious to cut?  I’m not forecasting that, simply reminding us all that assumptions need to be tempered.

As it is the last week of August with holidays rife around the Street, I suspect it will be very quiet overall.  At this point, we need more data to make decisions, so look for limited activity in the FX markets, although I guess the world is really waiting for Nvidia’s earnings tomorrow more than anything else.

Good luck

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The Time Has Come

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(with apologies to Lewis Carroll)

The time has come, the Chairman said,
To speak of many things.
Of joblessness and how inflation,
            Social unrest, brings
And whether we have done our job
            Although we live like kings
 
But wait a bit, the pundits cried
            Before you do explain
For we thought that inflation was
            The overwhelming bane
It was, the Chairman did remark
            But now its jobs that reign

 

On Friday morning, Fed Chair Jay Powell laid out his vision for the immediate future, and much as many had hoped, he was quite clear in his belief that the inflation mission is accomplished.

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Now, many of us remember how that worked out for the last official who exclaimed that concept a bit too early, but hey, maybe this time IS different!  At any rate, during his Jackson Hole speech, the below comments were what got speculative juices quickening, although a quick look at history indicates all may not be well, at least in the risk asset world.  But first to the soothing words of the Chairman [emphasis added]:

“The time has come for policy to adjust. The direction of travel is clear, and the timing and pace of rate cuts will depend on incoming data, the evolving outlook, and the balance of risks.”  

“We will do everything we can to support a strong labor market as we make further progress toward price stability. With an appropriate dialing back of policy restraint, there is good reason to think that the economy will get back to 2 percent inflation while maintaining a strong labor market. The current level of our policy rate gives us ample room to respond to any risks we may face, including the risk of unwelcome further weakening in labor market conditions.”

So, why, you may ask, would anything negative occur if the Fed is finally going to cut rates?  After all, lower rates add monetary stimulus and allow companies to borrow more cheaply while allowing individuals to reduce their borrowing costs and afford more stuff, like cheaper mortgages making houses more affordable.  But under the rubric, a picture is worth a thousand words, the following chart purloined from X in @allincapital’s feed, does an excellent job of highlighting how equity markets have performed after the Fed pivots to cutting rates.

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You may have notices that each pivot led to a substantial decline in the S&P 500.  Of course, if you think it through, the basic reason the Fed is pivoting is because the economy is typically heading into, or already in, a recession.  And there has never been a recession when corporate earnings rose across the board. 

This is the crux of the recession argument.  If those who are convinced we are already in a recession are correct, then the prospects for risk assets are dour at best.  On the other hand, for those who remain pollyannaish and believe that the data continues to point to economic strength, the first question is, why should the Fed cut?  And the second question is, why is the data showing rising unemployment, which has an almost perfect correlation of occurring during recessions, not indicating a recession this time?

One last thing, inflation.  You remember that bugaboo, the thing that has had the Fed’s undivided attention for the past two plus years.  Well, given that the money supply has resumed its growth, and money velocity continues to rise, while Chairman Powell has convinced himself that he won the battle, so did Chairman Arthur Burns…three times!  Friday, the equity bulls were in the ascendancy and the market moved to price a 36% chance of a 50bp cut in September with 100bps priced in for the rest of the year while the major indices all rose > 1%.  Personally, I’m a bit wary.

But enough of Friday.  It will take a great deal of new and contradictory information to change the narrative now with the next real chance the NFP report to be released on September 6th.  In the meantime, let’s see what happened overnight.  There was very little in the way of data or activity with only German Ifo readings showing a continuation in their trend lower, printing at 86.6.  It has become increasingly difficult to look at Germany, and its place within Europe as the largest economy by far, and not be concerned over the entire continent’s economic situation.  Energy policies around the Eurozone have hamstrung the economy significantly, and there is no indication that this is either recognized, or if it is, of concern to the governments across the continent.  I understand the short-term view that the Fed is going to start cutting rates and that the dollar has the opportunity to decline because of that, but the longer-term prospects for the euro seem far more dire, at least to my eyes.

Ok, let’s see how markets are handling the unmitigated joy of the Fed finally doing what everyone was so fervently wishing them to do.  In Asia, the Nikkei (-0.7%) didn’t get the bullish memo, likely suffering on the yen’s strength (+1.3% Friday, +0.2% this morning) which started on Friday, right as the Powell speech began.  However, the Hang Seng (+1.0%), India (+0.75%) and Australia (+0.8%) all followed the US movement.  Alas, mainland Chinese shares (-0.1%) continue to lag as the PBOC left rates on hold last night, although some were hopeful of another cut.  In Europe, Germany (-0.3%) is the laggard this morning, not surprisingly given the Ifo data, but overall, markets are moving very little with only the FTSE 100 (+0.5%) showing any life as the only market there following the US.  As to US futures, at this hour (7:10) they are essentially unchanged.

In the bond market, Treasury yields are unchanged this morning, but did fall 5bps on Friday.  In Europe, sovereign yields have all rebounded 2bps, basically unwinding the Friday declines seen in the wake of the Powell comments.  In truth, this is surprising given the lackluster data that was released from Germany, but markets can be that way.  As to JGB yields, they slipped 1bp lower overnight, still not showing any evidence that there is concern the BOJ is going to tighten policy substantially going forward.

In the commodity markets, oil (+2.6%) is rocketing higher after Israel initiated a pre-emptive attack on Hezbollah in Lebanon and Hezbollah responded.  While the WSJ headline is that both sides are now trying to de-escalate things, the oil market, which has seemingly been underpricing risks of a greater supply disruption, has woken up to those risks this morning.  Arguably part of that wakening was the fact that Libya just declared force majeure and has stopped pumping oil because of internal conflict over the central bank and its use of monetary reserves.  Hence, a supply disruption!  Remember, though, the Saudis have a decent amount of spare capacity to fill in if prices start to rise “too” quickly.  

In the metals markets, green is today’s theme with gold (+0.6%) continuing to show its luster as a haven asset.  Meanwhile, silver (+0.9%) has been gaining rapidly amidst stories that China is hording it along with stories that there is not enough silver around to meet the plans for all the solar panels that are still expected to be built.  This movement is dragging copper and aluminum higher as well.

Finally, the dollar is slightly higher this morning overall, although there are some reasonably large movers in smaller currencies.  Surprisingly, NOK (-0.9%) is under pressure despite the big move in oil price higher.  As well, NZD (-0.5%) has slipped, but that was after a very sharp rally on Friday of nearly 2% which seemed to be based on the Fed rate cut story, although NZD responded far more aggressively than any other currency.  We are also seeing weakness in MXN (-0.4%) and SEK (-0.5%) while the euro (-0.2%) and pound (-0.2%) hold up slightly better.  ZAR (-0.1%) may be the best performer today as the metals’ strength seems to be offsetting the dollar’s own strength.

On the data front, there is a decent amount of new information culminating in the PCE data on Friday.

TodayDurable Goods5.0%
 -ex transport-0.1%
TuesdayCase Shiller Home Prices6.0%
 Consumer Confidence100.6
ThursdayInitial Claims234K
 Continuing Claims1870K
 Q2 GDP (2nd look)2.8%
 Goods Trade Balance-$97.5B
FridayPCE0.2% (2.5% Y/Y)
 Ex food & energy0.2% (2.7% Y/Y)
 Personal Income0.2%
 Personal Spendinmg0.5%
 Chicago PMI45.5
 Michigan Sentiment68.0

Source: tradingeconomics.com

In addition to the data, we hear from Fed Governor Waller and Atlanta Fed president Bostic but given that Powell just basically gave the market the roadmap for the Fed’s thinking, it would be surprising if either one changed anything at all.  And given the next really important data point is NFP at the end of next week, Fed speak is likely not that important right now.

At this point, Powell has explained what the Fed is going to do, so the data will help traders and investors adjust the amount of risk they want to take, at least until the point where a recession is more obvious.  Maybe Powell will have successfully prevented a recession, but I still believe the odds are against him.  With that in mind, though, I expect the dollar will remain under pressure for as long as the market believes that Powell is going to cut more aggressively than everybody else.

Good luck

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Like a Stone

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When Ueda-san
Raised rates, stocks responded by
Falling like a stone
 
Now Ueda-san
Is treading lightly, lest an
Avalanche begins

 

I’m sure we all remember the day, just three weeks ago, when the Nikkei Index fell more than 12% leading to a global rout in stocks.  At that time, the proximate cause was claimed to be the combination of a more hawkish BOJ and a less dovish FOMC leading to a massive unwinding of the yen carry trade.  It was a great story, and almost certainly contained much truth.  But was it really the only thing going on?

It seems quite plausible that the dramatic market reactions at that time may have been sparked by that combination of central bank events, but the sole reason the moves were so dramatic was the fact that leverage in the markets has become a key driving force in everything that occurs.  This is the reason that central banks around the world, which continue to try to reduce their balance sheets, are forced to move so slowly.  There have already been two noteworthy accidents in balance sheet reduction processes; the September 2019 repo problem in the US and the October 2022 UK pension problem, both of which were exacerbated, if not specifically driven, by excess leverage.

With this in mind, the most recent market dislocation was the main topic of discussion last night in Tokyo when BOJ Governor Ueda was called on the carpet in a special session of the Diet to explain what he’s doing.  (As an aside, the underlying premise that cannot be forgotten is that despite all the alleged focus on economic outcomes, the only thing that gets governments exorcised is when stock markets fall sharply.  At that point, inquiries are opened!)

At any rate, last night, Ueda-san explained the following: “If we are able to confirm a rising certainty that the economy and prices will stay in line with forecasts, there’s no change to our stance that we’ll continue to adjust the degree of easing.” He followed that with, “We will watch financial markets with an extremely high sense of urgency for the time being.”  In other words, the BOJ is still set on tightening monetary policy but will continue with their major goal, which is to prevent significant market dislocation (read declines).  

The upshot here is that nothing has really changed, at least at the BOJ.  Given the pace with which the BOJ acts on a regular basis, it is not surprising that they expect to continue to tighten policy very gradually and will adjust the pace to prevent major financial market moves.  The market response to these comments was for the yen to rally initially, with the dollar falling nearly one full yen, but then reversing course as Ueda backed away from excessive hawkishness.

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Source: tradingeconomics.com

Which takes us to Chairman Powell and his speech this morning.

There once was a banker named Jay
Whose goal was for both sides to play
When joblessness rose
The question he’d pose
Was, see how inflation’s at bay?

It is somewhat ironic to me that the most recent market ructions were a response to the combined efforts of the BOJ on a Tuesday night and the Fed on a Wednesday morning, less than 12 hours apart.  And here we are this morning with Ueda-san having spoken on a Thursday night with Chair Powell slated to speak Friday morning, although this time a bit more like 15 hours apart.  Should we be concerned that more ructions are coming?
 
As per the above, it seems as though the BOJ is going to make every effort to tighten policy, albeit slowly, given that the inflation picture in Japan is not improving in the manner they would like to see.  In fact, last night, the latest figures were released showing that headline inflation remained at 2.8% and core rose a tick to 2.7%, although that was the expected outcome.  The one bright spot was their “super-core” reading fell to 1.9%.  In the past, I was given to understand that super-core was the number that mattered the most to the BOJ, but given Ueda seems keen to continue to tighten policy, I suspect it will not be the focus for now.
 
Which takes us to the other side of this equation, the Fed.  What will Chairman Powell tell us today?  Well, yesterday we heard both sides of the argument from FOMC members with Boston’s Susan Collins and Philadelphia’s Patrick Harker both explaining that the time for cutting rates was coming soon and that the process would be gradual.  On the other side, the host of the Jackson Hole shindig, newly named KC Fed president Jeffrey Schmid, explained, “It makes sense for me to really look at some of the data that comes in the next few weeks. Before we act — at least before I act, or recommend acting — I think we need to see a little bit more.”  
 
Based on the Minutes released on Wednesday, it certainly appears that the committee is ready to cut rates next month.  The real question is at what pace will they continue once they start.  Despite all the hubbub about the NFP revisions in the Twitterverse, none of the FOMC members interviewed explained that it altered their opinions about the economy.  As I type, three hours before Powell speaks, the Fed funds futures market is pricing a 26.5% probability of a 50bp hike with a 25bp hike fully priced in.  I have read arguments by some analysts that they need to start with 50bps because the payroll revisions paint a less positive picture of the economy.  But it is hard for me to believe that Powell will want to act more than gradually absent a major dislocation in the data still due between now and the next meeting.  If NFP is <50K or the Unemployment Rate jumps to 4.5% or 4.6%, that could see a 50bp cut, but otherwise, I believe Powell will be measured and not really give us anything new today.
 
Ok, let’s look at how markets have behaved ahead of his speech.  After yesterday’s disappointing US session, the Nikkei shook off any initial concerns about Ueda’s hawkishness and rallied 0.4% on the session.  But most of the rest of the region was in the red, with Hong Kong, Korea and Australia all sliding although the CSI 300 managed a 0.4% gain.  In Europe, though, green is the theme with every major market firmer this morning led by Spain’s IBEX (+0.7%) and Germany’s DAX (+0.65%).  There was no notable data, so it is not clear the driver here.  Of course, US futures are rallying at this hour as well, with the NASDAQ futures higher by 1.0% leading the way.  Based on these markets, there is clearly a belief that Powell will be dovish.
 
In the bond markets, Treasury yields have slipped 1bp this morning but have been hanging around the 3.85% level for several sessions.  There was a dip on Wednesday after the Minutes seemed dovish, but that reversed course before the day ended and we have done nothing since.  In Europe, investors and traders are also biding their time with virtually no change in yields there.  Finally, JGB yields did rise by 3bps in response to Ueda’s marginal hawkishness.
 
In the commodity markets, oil (+1.3%) is continuing to rebound from its recent lows in what looks like a technical trading bounce although the EIA data on Wednesday did show more inventory draws than expected.  In the metals markets, while yesterday was a terrible day in the space, with metals selling off hard during the NY session, this morning they have rebounded and are higher across the board.  Nothing has changed my view that if the Fed turns dovish, metals markets, and commodities in general, will rally sharply.
 
Finally, the dollar is under pressure this morning, slipping broadly, but not deeply.  The euro is unchanged, while the pound (+0.2%) and AUD (+0.4%) pace the gainers in the G10.  In the EMG bloc, ZAR (+0.4%), MXN (+0.3%) and KRW (+0.3%) all showed modest strength as it appears traders are looking for a somewhat dovish Powell speech as well.  The dollar will be quite reactive to Powell, I believe, so watch closely.
 
In addition to Powell, and any other FOMC members that are interviewed at the symposium, we only see New Home Sales (exp 630K).  Yesterday, Existing Home Sales stopped their declines and printed as expected at 3.95M.  Claims data was also as expected although the Chicago Fed National Activity Index printed at a much lower than expected -0.34 after a revision lower to the previous month.  That is a negative economic indicator.
 
This poet’s view is Powell will try to be as middle of the road as possible, acknowledging the likelihood of a cut in September but not promising anything beyond that.  That said, I believe the market is looking for a much more dovish speech.  If he does not provide that, I expect that we could see some market negativity overall with the dollar rebounding.
 
Good luck and good weekend
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Unnerved

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The Claims data last week preserved
The markets, which had been unnerved
By thoughts that Japan
Did not have a plan
To exit QE unobserved
 
Now yesterday’s data revisions
To Payrolls cemented decisions
That when Powell speaks
He’ll say, “in four weeks
Rate cuts are quite clear in my visions”

 

Well, the big news was that the BLS revised down the number of new jobs created between April 2023 and March 2024 by 818K, not far from the extreme calls of 1MM.  Alas, this has become more of a political talking point than an economic one with claims of subterfuge on the part of the current administration in an effort to flatter their record.  From an economic perspective, however, to the extent that we believe this data is accurate, it offers a far greater case for the Fed to cut rates next month.  After all, the strong labor market had been one of the key rationales for the Fed to maintain higher for longer, so if that market is not as strong as previously believed, lower rates would be appropriate.

In addition to the NFP revisions, which had gotten virtually all the press, the FOMC Minutes of the July 31stmeeting were also released.  It turns out that according to those Minutes, the discussions in the room included several members calling for a cut at that meeting, and unanimity in a cut by September.  That feels a bit more dovish than the post-meeting press conference where Powell wouldn’t commit to a September cut, seemingly trying to retain some optionality.  Now, the market has been pricing in a full 25bp cut since a week before the last meeting, so it’s not as though people have been fooled.  And we are still looking at a 30% probability of a 50bp cut in September, but to this poet, absent a negative NFP reading in two weeks’ time, September is going to bring a 25bp cut.

Here’s the thing, though, will it matter?  It certainly won’t have any impact on the economy for any appreciable time (remember those long and variable lags) although it could be a signaling event.  But exactly what does it signal?  If the economy is truly robust, why cut?  If the economy is weakening quickly, or not as strong as previously thought, then why just 25bps?  In the big scheme of things, 25bps has exactly zero marginal impact on economic activity.  If they were to explain they are entering a series of more aggressive rate cuts to accommodate weakening growth, well that seems like a signal they don’t want to send either, especially politically.  One final thought, when things are going well in the economy, nobody is talking about any kind of ‘landing’, whether soft or hard.  The very fact people are discussing a ‘soft-landing’ is recognition that the economy is slowing down.  I believe that most of us understand that is the case, but for the media to inadvertently admit that is the case in this manner speaks either to their stupidity or their cupidity.

Ok, so how did markets respond to these two stories?  The first thing to note is that while the NFP revisions were scheduled to be released at 10:00, they were a bit late.  As you can see in the chart below, there was an immediate jump in the equity market, which slowly retraced until the Minutes were released and then the dovishness was complete, and we saw a steadier appreciation.  

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Source: Bloomberg.com

Net, the clear belief from the investment community was that the Fed is more dovish than they have been letting on, and so equity markets in the US rallied on the day.  Once again, that followed through in Asia, where pretty much all markets except mainland China (CSI 300 -0.25%) followed suit with the Hang Seng (+1.45%) the leader, but strength throughout the region overall.  In Europe, Flash PMI data was released this morning showing that Germany continues to stumble, especially in the manufacturing sector, and that the whole of Europe is lackluster at best.  While the Olympics seemed to help French services output, net, there is not much excitement.  The upshot is that ECB members are talking up further rate cuts and the result is European bourses are gaining some ground this morning, but only on the order of 0.2%.  As to US futures, they are little changed at this hour (7:15).

In the bond market, yields are edging higher with Treasury yields up by 2bps and similar gains across Europe and the UK.  In truth, I would have expected European yields to slide a bit on the PMI data, but clearly that is not the case.  Interestingly, 10yr JGB yields slipped lower by another 1bp as the market there prepares for testimony by BOJ Governor Ueda tonight.  In a truly unusual event, the Diet (Japan’s congress) called him in to testify before both the Lower and Upper houses even though it is technically not in session.  It seems they are very concerned about his hawkishness and how it impacted Japanese stock markets and the yen two weeks ago.  (As an aside, I cannot imagine something like that happening in the US, it would be extraordinary given the ostensible independence of the Fed.)

Turning to commodity markets, after falling 1% further yesterday, oil (+0.5%) is bouncing slightly, although it remains far closer to the lower end of its trading range than even the center.  Gold (-0.3%) continues to hang around just above $2500/oz but has not made any real headway above since it first broke through that level last Friday.  A very interesting X thread on this subject by Jesse Colombo (@TheBubbleBubble), a pretty well-known commentator on markets (167K followers on X),  highlighted that while gold has made new all-time highs vs. the dollar, it has not done so vs. other currencies and that process needs to be completed to see a more significant move.  I raise this idea because if/when it occurs, it is likely to be a signal of far more distress in the economy and markets than we are currently seeing.  As to the rest of the metals complex, they are having lackluster sessions as well, with copper ceding -1.0% and silver (-0.15%) a touch softer.

Finally, the dollar refuses to collapse completely despite the growing view that the Fed is getting set to embark on a series of rate cuts.  While both the euro (-0.2%) and pound (+0.1%) are little changed this morning, both sit near 1-year highs vs. the dollar.  The thing about both these currencies that has me concerned is that energy policies currently being implemented in both Germany and the UK, with many other continental countries going down the same path, are almost guaranteed to destroy all manufacturing capability and force it to leave for somewhere with lower energy prices.  While both of those economies are clearly services driven, I assure you that the destruction of manufacturing capacity is going to have long-term devastating impacts on those nations, and by extension their currencies.  Just something to keep in mind.  Elsewhere, the yen (-0.6%) is slipping today and has been in a fairly tight range since the pyrotechnics from two weeks ago.  But we are also seeing weakness in ZAR (-0.75%), NOK (-0.5%) and SEK (-0.4%) to name a few, and general weakness, albeit in the -0.2% to -0.3% range across the rest of the G10 and EMG blocs.  The dollar is not dead yet.

On the data front, this morning brings Initial (exp 230K) and Continuing (1870K) Claims as well as the Chicago fed National Activity Index (.03) at 8:30.  Later this morning, Flash PMIs (manufacturing 49.6, services 53.5) are due and then Existing Home Sales (3.93M) finishes things off.  There are no scheduled Fed speakers but then all eyes are on Jackson Hole tomorrow when Chairman Powell speaks.

Given what we learned yesterday regarding both the labor market and the last FOMC meeting, it seems clear the Fed is going to cut 25bps next month.  Of more interest, I believe, will be the way Powell lays out his vision for what needs to occur for the Fed to continue the process and his guideposts.  Remember, they are still shrinking the balance sheet, albeit slowly, but cutting rates and reducing liquidity simultaneously may have unintended consequences.  If they stop shrinking the balance sheet, though, I believe the market will view that as a very dovish signal, and the dollar would fall sharply.  I’m not saying that’s what I expect, just that would be the result.  But for today, it is hard to believe we see a large move ahead of tomorrow’s speech.

Good luck

add

Waxes and Wanes

Posted on by

The story of note for today
Is how will the BLS play
Employment revisions
And then what decisions
Will Powell be likely to weigh?
 
For now, markets still seem assured
That rate cuts will soon be secured
The doves still want fifty
But most are more thrifty
With twenty-five likely endured
 
But what if Chair Powell decides
Inflation, just like ocean tides
Both waxes and wanes
And though they’ve made gains
No rate cuts, to Fed funds, provides

 

So, the big story today, which I briefly discussed on Monday, is that the BLS is going to make benchmark revisions to their NFP data for the year through March 2024.  These revisions come from a closer analysis of the Quarterly Census on Employment and Wages (QCEW) data, which is the most comprehensive data set on jobs available.  Remember, for their monthly reports, the BLS uses a model that incorporates samples of data from respondent companies, and then includes their own adjustments based on the birth-death model of new businesses and how many jobs they create.  But the QCEW data doesn’t model things, it counts all the data from states regarding unemployment insurance and reports required to be filed by companies regarding quarterly contributions.  It is the gold standard.

Naturally, when the QCEW is released (the most recent was released in June), the analyst community goes through everything and makes their own estimates as to the changes that will occur.  Prior to any revision, the BLS data show that the economy added 2.9 million jobs in the 12 months from April 2023 through March 2024.  But analyst estimates range from a reduction in that number ranging from 300K to as much as 1 million fewer jobs.  

Given the increased importance the Fed has placed on the employment side of their mandate lately, and given that one of the reasons, if not the key reason, Powell has been willing to leave rates at current high levels is the employment situation has remained robust, if he and his colleagues were to suddenly find out that there were one million less employed people around, that would likely have a serious impact on their views as to where rates should be.

Based on the stories that I have seen on this topic over the past several days, as well as the positioning that is being revealed by the Commitment of Traders’ reports showing massive long positions in both treasury bond futures and SOFR call options, both of which are real money expressions of expectations of lower interest rates coming soon, it strikes me that the pain trade is the opposite.  In other words, what if this revision is much smaller than the largest estimates, maybe 100K or something.  Suddenly, the idea that the Fed is going to be pressured into cutting rates despite the fact that inflation, though lower, remains well above their target, is not quite as certain.  

The thing is, based on what I keep reading and hearing, it strikes me that the market is set up for a bond sell-off and higher yields today.  Either, the number is large, about 1 million jobs removed, and then we will see profit taking on the outstanding positions, or the number is small, and the entire story needs to be rewritten regarding the timing of the first rate cut, which means that positions need to be abandoned.  I’m not sure what the goldilocks number needs to be to have traders maintain their positions ahead of Friday’s Powell speech, but given that is a wild card as well, I think that is the least likely outcome, no change in positions.

Elsewhere, the only other noteworthy thing was a story about a BOJ staff paper that discussed the idea that inflation in Japan is still structural and that higher rates are still appropriate, but that is a staff paper, and not necessarily Ueda-san’s view.  The BOJ next meets on September 20, two days after the FOMC, so Ueda-san will have lots more new information to decide just how hawkish he wants to be.  Recall, the dramatic market collapse in Japan at the beginning of the month, while completely reversed now, forced their hand to back off their hawkishness.  Perhaps, the second time, if they remain hawkish, they will be able to withstand that type of movement.

So, as we all await this BLS revision, which comes at 10:00 this morning, here is how things behaved overnight.  After the first down day in the US in 9 sessions, Japanese (-0.3%) and Chinese (-0.3%) markets were also soft although the rest of the region was mixed with some gainers (India, Indonesia, Australia) and some laggards (Hong Kong, Taiwan, New Zealand).  In Europe, though, equity markets are modestly firmer this morning, somewhere between 0.25 and 0.5%, although there has been a lack of new information seemingly to drive things.  As to the US, futures at this hour (7:30) are edging higher by about 0.1%.

In the bond market, Treasury yields have edged up 1bp this morning, although they have been trending down for the past week in anticipation of this BLS employment adjustment.  European sovereign yields are essentially unchanged this morning while JGB yields dipped 1bp.  The story there remains that 10-year JGBs are yielding well less than 1.00%, the perceived key level at which more Japanese funds flow home.  I think we will need to see a much more hawkish BOJ to get that trade going.

In the commodity markets, oil (0.0%) has stopped falling for the time being, but remains under pressure overall, down more than 6.6% in the past month.  Yesterday’s API data (the private sector version of the EIA data to be released later this morning) showed a small build of inventory as opposed to the continued draws that we have seen lately and that were expected.  However, a look at the oil chart tells me that we are much closer to the bottom of its trading range for the past 3 years, than the top, and seem likely to rebound a bit.  Gold (-0.15%) is consolidating its recent gains and remains above that big round $2500/oz level but both silver (+0.5%) and copper (+0.5%) are rallying today.  I keep reading stories about how the physical shortages in both those markets, due to increased production of solar panels and batteries, is going to become the key driver going forward.  While I have believed that story, it is always hard to ascribe a given day’s movement to something like that absent a major new piece of information, and I haven’t seen that piece of the puzzle.

Finally, the dollar is bouncing slightly this morning, although that is after a pretty straight-line decline for the past two months.  Given the hype about Fed rate cuts, especially adding in this new focus on the BLS job data adjustment, it is easy to see why traders are looking for much lower US rates and therefore selling the dollar.  But remember, in the big scheme of things, at least based on the Dollar Index, the dollar is pretty much at its long-run average, neither weak nor strong.  I will say that if the Fed does enter a serious rate cutting cycle, the dollar is likely to weaken quite a bit more, perhaps with the euro testing 1.15 – 1.20 before it ends.  However, remember, if the Fed starts cutting aggressively, so too will the ECB, BOE and BOC, so any weakness will be somewhat limited.  As to today’s price action, the dollar’s strength is universal, but pretty modest overall with the biggest mover JPY (-0.5%) although obviously there are other things ongoing there.  

Aside from that employment report revision, there is no other data to be released and there are no Fed speakers scheduled today.  Today will be driven by that revision.  The larger the revision, the more likely we see the dollar decline, although the initial reaction on interest rates may be opposite on profit taking.

Good luck

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Waiting for Jay

Posted on by

While everyone’s waiting for Jay
And hope he’s got good things to say
No stories of note
Have lately been wrote
And bulls keep on getting their way
 
The only place that’s not been true
Is China, where, policies, new
Allow new home prices
To make sacrifices
And slide hoping sales follow through

 

Although there has been a dearth of new information to drive activity, at least with respect to hard data, equity markets are mostly trading higher as the rebound from the early August correction continues.  In the US this week, the big news won’t be out until Friday, when Chairman Powell speaks at the Jackson Hole symposium.  Elsewhere, while we do see things like both Japanese and Canadian inflation as well as the flash PMI data, so much importance has been attributed to the Powell speech, it is hard for traders to get excited about very much.  For instance, early this morning the Swedish Riksbank cut their policy rate by 25bps, as expected, and indicated that there could be another 3 cuts during 2024, but nobody really cared.  In fact, the Swedish stock market is lower on the day, simply proving that rate cuts are not a stock market panacea.

However, not every nation is using the same playbook right now, and while Japan may be the biggest outlier, attempting to tighten monetary policy, albeit not as successfully as they had hoped, China is taking a different approach to fiscal and economic policy.  As I have mentioned before and has been widely reported for the past several years, the property market in China has been under severe stress.  What has become a bit clearer in that time is that much of the Chinese growth miracle was the result of massive overinvestment in housing.  The stories about ghost cities, that were built but where nobody lived, which had made the rounds for a while turned out to be true. 

In essence, a key driver of the Chinese economy was the property market.  Cities and states would sell land to property developers, using the funds to help themselves develop infrastructure.  Meanwhile, property developers had a ready market for their homes (mostly condos in high rises) as the Chinese people felt more comfortable with property as a savings vehicle than banks or the stock market.  Looking at the performance of the Shanghai Composite below, it is no wonder that people gravitated toward property.  After a peak in the summer of 2015, the PBOC devalued the renminbi 2%, stocks fell nearly 50% in the ensuing six months, and have remained at that lower level ever since.

A graph with numbers and lines Description automatically generated

Source: tradingeconomics.com

But for the past four years, since China Evergrande, a major property developer, started to crumble, the desire of the Chinese people to own property has greatly diminished.  This has had a major impact on Chinese local government finances as the demand for property they were selling to fund themselves collapsed.  At this point, there is a glut of unfinished homes around as developers ran out of funding, so the country is in a bad spot.  Not surprisingly, one of the problems is regulatory, as Chinese city and state governments have had restrictions on new home prices, trying to prevent them from declining thus keeping the cycle of new homes funding the cities ongoing.  But recently, some major cities and states have relaxed those restrictions and suddenly, new home prices have fallen to make them competitive with resales.  Remarkably, sales volumes are picking up.  Who would have thunk?  

It is ironic that Communist China is defaulting to market pricing activity to help markets clear while in the ostensibly capitalist US, we have a major party seeking to intervene in housing markets to achieve a social goal of home ownership, regardless of the fact it will push prices higher.  At any rate, the upshot is that property prices in China continue to decline which is weighing on the share prices of those developers that have not already gone bust.  And that is dragging down the entire Chinese stock market and adding to that underperformance we see above.

But you can tell it is a slow day if that is the most interesting story I can discuss!  So, without further ado, let’s take a look at the overnight activity as we await the NY open.  While the CSI 300 (-0.7%) and Hang Seng (-0.3%) were both in the red, the rest of Asia followed the US higher with Japan (+1.8%) and Korea (+0.8%) leading the way higher.  As to European bourses, it is much less exciting as continental exchanges are all +/- 0.1% from yesterday’s close although the FTSE 100 (-0.6%) is under a bit of pressure with the energy sector weighing on the index amid the decline in oil prices.  As to US futures, they are essentially unchanged at this hour (7:20).

In the bond market, the doldrums also describe the price action with Treasury yields unchanged on the day and the same virtually true across all of Europe and Asia.  This is a situation where it is very clear that both traders and investors are waiting anxiously for Godot Powell.

While oil prices have stopped their slide this morning, they have fallen -6.0% in the past week as the slowing growth/recession story is on the minds of traders everywhere.  Concerns over supply on the back of either Ukraine/Russia or Israel/Iran are clearly no longer part of the discussion.  It feels to me like that is somewhat short-sighted, but I am not an oil trader.  In the metals markets, the barbarous relic (+0.85%) continues to pull all metals higher as it is trading at yet another new all-time high this morning ($2525/0z) and dragging silver (+1.3%) and copper (+0.2%) along for the ride.  While the silver movement makes some sense given it has precious characteristics, copper is wholly an industrial metal, so it is giving opposite signals to the oil market.  They both cannot be right.

Finally, the dollar remains under pressure, with the euro (-0.1% today, +0.75% this week) pushing toward its end 2023 highs.  Remember, back then, markets were pricing 6-7 Fed rate cuts this year, something which is clearly not going to happen.  As well, we are seeing the strength in CHF (+0.3%), SEK (+0.3% despite the rate cut and threats of more) and JPY (+0.2%). Interestingly, in the EMG space, ZAR (-0.6%) and MXN (-0.6%) are both under pressure this morning despite the rally in metals markets.  As well, I guess given the general malaise in China, it can be no surprise that the renminbi (-0.2%) has fallen.  Perhaps a more interesting thing to consider is the fact that the renminbi fixing has been right around current market levels, an indication that pressure on the PBOC to devalue has faded, and a sign that the dollar is losing some fans.  In fact, I suspect that this is a key feature of the dollar’s recent softness, and if the Fed does get aggressive, do not be surprised if the market pushes USDCNY to the other side of the +/- 2% trading band around the fix.

On the data front, there is no US data today at all, with the most interesting thing to be released being the Canadian inflation report (exp 2.5%).  We do hear from two Fed speakers this afternoon, Atlanta Fed president Raphael Bostic and Governor Michael Barr, but with Powell on the horizon, it would be hard for them to get much traction in my view.  As an aside, the Atlanta Fed’s GDPNow has fallen to 2.0% as of last Friday, down nearly 1% last week.  This, of course, is another brick in the recession story.

Net, today seems like it will be a quiet one, with markets biding their time until Friday.  Of course, given that these days, biding their time means equities will keep rallying and the dollar keep sliding, I think that seems like the best bet for now.

Good luck

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