Tag Archives: #Powell

A Financial Home Run

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Seems President Xi isn’t done
And last night he added a ton
Of new stimuli
In order to try
To hit a financial home run
 
The market response has been clear
Forget anything that’s austere
It’s buy with both hands
Ere Powell rebrands
QE as just more Christmas Cheer

Things are obviously worse in China than President Xi had been willing to let on for the past several months/years, as after two straight days of monetary policy stimulus announcements, they pulled out the big guns and got the fiscal side of the process involved.  Last night the Politburo pledged further support after a surprise meeting to discuss economic policies.  Their economic discussions have historically only occurred in April, July and December, so this was the latest indication that Xi is really concerned. 

Some of the actions include an (unspecified) effort to make the real estate market “stop declining”, limiting construction of new home projects, issuing CNY 2 trillion of special sovereign bonds to disburse funds to help fund financial assistance for low-income workers, shore up bank capital to encourage more lending and support further investment in productive capacity as well as to potentially buy up unfinished homes.  

Obviously, Xi was quite concerned that the country would not achieve his 5% GDP growth target for 2024 as an increasing number of analysts around the world were penciling in slower growth, and he decided he could not wait until December for the next policy adjustments.  Remember, too, that next week is a week-long Chinese holiday, so part of the impetus was to give cash to people to encourage more spending/activity.  While it is far too early to determine how effective these new policies will be at supporting real, organic economic activity, they did wonders for equity markets and risk assets around the world.

And really, that continues to be the main story.  With the Fed now having confirmed that lower rates are appropriate, I would look for almost every nation to boost stimulus, both monetary and fiscal, especially in the wake of recent election results which have seen incumbent after incumbent tossed from office.  After all, what good is being in power if you cannot buy your way to re-election?

So, how has all this impacted financial markets this morning?  You will not be surprised to see that risky assets are in huge demand with equity markets rallying everywhere along with metals, while haven assets see much more modest demand, with bond yields having slipped just a bit lower.

Yesterday’s mixed US market performance is but a distant memory this morning with Asian shares roaring higher (Nikkei +2.8%, Hang Seng +4.2%, CSI 300 +4.2%) and gains virtually across the region, albeit not quite as robust as those.  But after the Fed cut, this fiscal stimulus from China is seen as helping everybody.  Europe, too, is rocking this morning with gains well above 1.0% everywhere (DAX +1.2%, CAC +1.6%, IBEX +1.1%) except the UK (FTSE 100 +0.2%) which continues to struggle as the Labour government is shown to be further and further out of its depth with respect to actually running things rather than carping about how the Tories did it.  And not to worry, US futures are all racing higher as well this morning, higher by between 0.3% (DJIA) and 1.5% (NASDAQ) at this hour (7:15).

In the bond market, Treasury yields have edged lower by 2bps and remain far below the Fed funds rate.  It is not clear if this is the market anticipating a more significant economic slowdown or simply a continued manifestation of the fact that the Fed still owns a significant portion of the debt outstanding and so has restricted supply at the margin.  In Europe, yields are also lower, with the riskiest nations seeing the biggest declines as risk assets are in vogue this morning.  Thus, Italy (-7bps) and Greece (-6bps) have moved the farthest, but otherwise we are seeing movement on the order of -3bps elsewhere.  In another quirk, and a telling comment on the state of France’s finances, Spanish 10yr bonos now yield less than French 10yr OATs for the first time in more than 15 years.

Turning to commodities, oil (-2.8%) didn’t get the China rebound memo and has tumbled nearly $2/bbl falling well below the $70/bbl level.  It seems that Saudi Arabia is dropping its price target and preparing to increase production, something the market has been fearing.  As well, in Libya, which had not been producing lately due to political issues, it appears a tentative agreement is in place that will allow for more supply on the market.

But you know what really benefits from a lot of deficit spending and the effective abandonment of inflation targets?  That’s right, precious metals as gold (+0.8%) continues its steady move higher to new all-time highs and quickly approaches $2700/oz.  This has taken both silver (+2.2%) and copper (+2.2%) along for the ride and there is currently no end in sight.

Finally, the dollar is under pressure this morning in a classic risk-on reaction.  AUD (+0.9%) is the leading G10 gainer on the back of its strong metals exposure while NZD (+0.8%) is right behind.  But the dollar’s weakness is manifest in Europe (EUR +0.2%, GBP +0.5%, SEK +0.5%) as well as against most EMG currencies.  In fact, CNY (+0.55% and below 7.00) is one of the biggest movers today although we are seeing strength in KRW (+0.7%), MXN (+0.5%) and ZAR (+0.4%), an indication that this move is widespread.  As long as the perception remains that the Fed is going to lead the way to lower interest rates, I can see the dollar underperforming.  However, as soon as we see other nations become more aggressive, this move will abate.

On the data front, there is much on the calendar this morning starting with the weekly Initial (exp 225K) and Continuing (1832K) Claims data as well as the 3rd look at Q2 GDP (3.0%).  We also see Durable Goods (-2.6%, +0.1% ex-Transports) and then the ancillary data that comes with the GDP report including Real Consumer Spending (2.9%), Final Sales (2.2%) and the GDP PCE indicator (2.5% headline, 2.8% core).  But perhaps of far more importance, we hear from a host of Fed speakers this morning.  Governor Kugler and Boston Fed president Collins speak about financial inclusion, Governor Bowman discusses the economy and monetary policy, Governor Cook discusses AI and workforce development, Vice-chair Barr discusses regulation and Chairman Powell gives the opening remarks at the US Treasury Market Conference in NY. 

Yesterday, Governor Kugler added to the ‘mission accomplished’ view on inflation at the Fed and lauded the move to focus on Unemployment.  I would contend this is the key issue right now, the fact that central banks around the world, but particularly the Fed, have determined that the inflation fight is over.  While we may very well touch 2.0% core PCE in the next months, it strikes me as highly unlikely that level will be maintained.  Rather, 2.0% is now the floor and if the Unemployment Rate behaves in its historic manner, accelerating higher now that it has started to move in that direction, look for much sharper interest rate cuts, much higher inflation and a much weaker dollar.  To me, that is the biggest risk.  However, if Unemployment follows the Fed’s projected path, and stays quiescent, then the current slow decline in rates and a very gradual decline in the dollar seems more likely.

Good luck

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Recalibration

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All week we had heard many clues
That fifty is what Jay would choose
And that’s what he cut
With only one but
From Bowman, who shuns interviews
 
The key is now recalibration
In order to tackle inflation
Without driving higher
The joblessness spire
So, trust us, it’s all celebration

 

“Recent indicators suggest that economic activity has continued to expand at a solid pace. Job gains have slowed, and the unemployment rate has moved up but remains low. Inflation has made further progress toward the Committee’s 2 percent objective but remains somewhat elevated.” [emphasis added]

Reading the opening paragraph of the FOMC Statement, it might be confusing as to why they needed to cut rates 50bps.  After all, the economy is expanding at a solid pace (In fact, after the Retail Sales data on Tuesday, the Atlanta Fed’s GDPNow reading for Q3 is up to 3.0%!)  unemployment remains low and inflation is still somewhat elevated.  I know I am a simple poet, but the plain meaning of those words just doesn’t lead my thinking to, damn, we better cut 50 to get started.  But I guess that is just another reason I am not a member of the FOMC.

Perhaps the more interesting thing was the Summary of Economic Projections and the dot plot which showed that while expectations were for rates to fall far more dramatically than in June, the longer run expectations continue to rise.  In fact, Chairman Powell specifically addressed the SEP in the press conference, “If you look at the SEP you’ll see that it’s a process of recalibrating our policy stance away from where we had it a year ago when inflation was high and unemployment low to a place that’s more appropriate, given where we are now and where we expect to be, and that process will take place over time.” [emphasis added] In fact, there was a lot of recalibrating going on as that appears to be the Chairman’s new favorite word, using it 8 times in the press conference.

Source: federalreserve.cgov

Notice that their current forecasts are for GDP to slow to 2.0% with Unemployment edging only slightly higher while PCE inflation magically returns to their 2.0% target.  And take a look at the last two lines, with the Fed funds rate projections falling substantially for the next three years, far more quickly than their previous views, although they think the long-run level will be higher.  

I wonder about that last issue.  Historically, the thought was that the long run Fed funds rate would be inflation (2.0%) + real interest rate (0.5%) and they pegged it at 2.5% for years.  Now that they see it at 2.9%, is that because they think inflation is going to be higher (not according to their projections) which means that for some reason they think real interest rates are going to be higher.  However, when asked, Chairman Powell and every member of the board has been unable to explain this change.

But what really matters is how have markets responded to this earth-shattering news?  The initial movement was as expected, with stocks rallying sharply (see chart below) and yields sliding along with the dollar while commodities rallied.

Source: Bloomberg.com

But a funny thing happened on the way to the close, as can be seen in the chart.  Stocks gave back all their gains and then some, with all three major indices lower on the session while 10yr Treasury yields backed up 7bps and the dollar rebounded.  Arguably, this was a sell the news response, but we need to be careful.  Remember, there are many analysts who believe the economy is in deep trouble already and by starting off with a big cut, those with paranoia may be wondering what the Fed knows that the data, at least the headline data, is not really showing.

So much for yesterday, now let’s look at markets this morning beyond the initial knee-jerk responses.  Absent any other major news or data (Norgesbank leaving rates on hold doesn’t count as major), markets have played out far more along the lines of what would have been expected in the wake of a 50bp cut.  In other words, the dollar has fallen sharply against almost all its counterparts, equity markets have rallied around the world, commodity prices have rallied sharply, and bond yields are…unchanged? 

Which brings us to the question that has yet to be answered.  Which market is right, stocks or bonds?  They appear to be telling us different stories with stocks pushing to new highs amid rising multiples and rising profit growth expectations while bonds are pricing in another 200bps of rate cuts by the end of 2025, an outcome that would only seem to make sense in the event the economy fell into a recession.  But if we are in a recession, corporate earnings seem highly unlikely to rise as much as currently forecast and typically, P/E multiples contract.  Meanwhile, if the economy is humming along such that current equity pricing is warranted, what will be the driver for the Fed to cut rates as that will almost certainly reignite inflation.  

History has shown that the bond market tends to get these big questions right when they are pointing in different directions, but that doesn’t mean that risk assets will stop rallying right away.  In fact, this will likely take quite a while to play out.

Ok, so let’s put a little more detail on the market activity overnight.  Tokyo rocked (+2.0%) as did Hong Kong (+2.0%), Taiwan (+1.7%), Singapore (+1.1%) and even mainland China (+0.8%) managed to rally some.  It appears that investors around the world believe the Fed has opened the floodgates for a much lower interest rate environment everywhere.  European bourses, too, are sharply higher led by the CAC (+2.1%) but with strength across the board (DAX +1.5%, FTSE 100 +1.3%).  And US futures have shaken off the late selloff yesterday and are firmly higher this morning led by the NASDAQ (+2.2%).

Bond yields, though, are largely unchanged on the day, with yesterday’s backup in Treasury yields maintained and European sovereigns all within 1bp of yesterday’s close.  It appears that bond investors are less confident in a soft landing than equity investors.  Interestingly, JGB yields rose 2bps last night as Japanese markets prepare for the BOJ meeting tonight.

In the commodity markets, oil (0.75%) is continuing its recent rebound after another massive inventory draw was revealed by the EIA yesterday prior to the Fed meeting.  There is a growing concern that inventories in Cushing, Oklahoma are falling to a point where products like gasoline and diesel will not be able to be produced.  As an example, gasoline futures have risen far more than crude futures this week on that fear.  As to the metals markets, gold briefly touched $2600/oz yesterday immediately in the wake of the FOMC but sold off hard afterwards.  This morning, however, it is back pushing up to that level again and the entire metals complex is rising nicely.

Finally, the dollar, has been a whipsaw of late.  Post the FOMC, it fell sharply across the board, and then into yesterday’s close it rebounded to close higher on the day.  However, this morning it has given back all those late gains and then some, and is now sitting at its lowest level, at least per the DXY, since April 2022.  This morning, in the G10, we are seeing many currencies rally between 0.5% (EUR) and 1.3% (NOK) vs the dollar and everywhere in between.  The one exception to that is the yen (-0.2%) which is biding its time ahead of the BOJ meeting.  The working assumption is that the BOJ will do nothing tonight, but now that the Fed has cut 50bps, and given Ueda-san’s history of actively trying to surprise markets to achieve outcomes he wants, we cannot rule out another rate hike in Japan.  Monday morning, USDJPY fell below 140 for the first time in 18 months.  My take is Ueda-san is quite comfortable with it heading back to the 130 level, if not the 120 level.  If he were to surprise markets and raise the base rate by even 10bps tonight, I think we would see a sea change in sentiment and a much lower dollar.  And given inflation in Japan seems to have stalled at 2.8%, well above their 2.0% target, he has a built-in excuse.

Too, watch the CNY (+0.45%) as it is now trading at its highest level (weakest dollar) in more than a year, and is approaching the big, round number of 7.00.  the linkage between JPY and CNY is tight as they constantly compete in markets, especially now in autos and electronics.  If the Fed is really going to cut as much as markets are pricing, both these currencies should strengthen much further.

It is almost anticlimactic to discuss the data today but here goes.  First, the BOE left rates on hold, as expected and the market impact was limited.  Expectations are they will cut next in November.  As to data, we see Initial (exp 230K) and Continuing (1850K) Claims, Philly Fed (-1.0) and Existing Home Sales (3.90M).  None of that is likely to change any views.  Prior to the BOJ meeting, at 7:30 this evening we see Japanese CPI, which may change views there.

For now, the dollar is very likely to remain on its back foot as enthusiasm builds for multiple rate cuts by the Fed going forward.  However, if the data continues to impress like it has lately, that enthusiasm will need to be tempered.

Good luck

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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.

A person in a suit and tie Description automatically generated

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.

A screenshot of a graph Description automatically generated

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
Adf

Unnerved

Posted on by

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

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