Tag Archives: #Powell

A Future, Austere

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So, what if the payroll report
Was wrong, and job numbers fall short
When they are revised
And so, they disguised
The ‘conomy’s on life support
 
Will this mean recession is here
And Jay will get rate cuts in gear?
But if that’s the case
Are stocks the right place
To hide with a future, austere?

 

After last week’s remarkable rally that has reversed so much of the negativity inspired by the BOJ/yen carry trade unwind/end of the world scenarios from just two weeks ago, this week is starting off in a fairly muted manner.  Add to this the fact that the data stream this week is limited, and you have all the makings of a quiet, summer doldrums-like, period.  Except…Thursday begins the KC Fed’s Jackson Hole symposium and Friday morning at 10:00am EDT, Chairman Powell will be speaking.  This speech often has great significance as historically, Fed chairs will give strong clues about policy changes coming at this exact opportunity.  This is not to say Powell is going to give us a schedule of his planned rate cuts, but more that he has the chance to explain his (and by extension the Fed’s) reaction function to future data releases.

It is this topic that is critical for us to monitor as lately there have been several articles regarding the nature of the annual benchmark revisions to the payroll reports that will be coming early next year.  The punch line is that expectations are growing that much of the NFP growth seen thus far in 2024, currently totaling ~1.4 million new jobs, may be erased, with estimates of downward revisions rising to 1 million or more.  For instance, in California, the Legislative Analyst’s Office, which is a non-partisan (assuming such a thing exists) group under the auspices of the California state legislature, has revised down their job growth estimates for all of 2023 to just 9K from well in excess of 100K in the initial reporting.  Given California’s status as the largest state in the union and its general importance to the economy, this is quite concerning.  

The BLS revisions will not be released until March 2025, but there have been numerous concerns registered by economists and analysts of all stripes indicating that the BLS model, specifically the birth-death portion regarding new businesses, is wildly out of sync with the reality on the ground.  One of the things that has allowed the Fed to maintain their higher for longer stance is their belief, based on the BLS data, that the employment situation is still quite solid in the US.  Of course, the recent rise in the Unemployment Rate is beginning to raise some eyebrows, but those who believe there is no recession will point to the increase in job seekers in the latest report, essentially raising the numerator rather than reducing the denominator in that data point. And maybe that is true.  However, the vibe that appears to be growing around the country is that the job situation is not as robust as the numbers might indicate.

The implications of this are that it is entirely possible that the minority of analysts who claim we are already in a recession will turn out to have been correct, and the NBER will backdate the beginning of the recession to early this year.  As to the Fed, they will find themselves in a much different place and be forced to cut rates far more aggressively than what seems to be the current belief in the Eccles building.

Right now, the Fed funds futures market is pricing in a bit more than 200 basis points of cuts by September 2025.  While that seems like a lot, if the economy is actually in recession already, that is likely understating the case.  When it comes to the tradeoff between inflation and recession, while Powell was able to talk tough regarding recession when it didn’t seem to be coming, methinks he will have a different tone if these job numbers are revised as dramatically as some are contending.  And let’s face it, if the California government is explaining that is the case, along with some research by the Philly Fed, which is also indicating less job growth than initially reported, this could well be the 2025 story of note.

To summarize, questions regarding actual job growth vs. reported job growth are starting to be asked.  If the answers lean toward the negative end of the spectrum, the likelihood of more aggressive Fed easing rises. However, the specter of inflation looms large in the background as despite its seeming recent quiescence, it is not nearly back at the Fed’s target level.  Can the Fed cut aggressively if inflation remains above target?  Of course they can, and if the economic situation deteriorates rapidly, they almost certainly will.  But that will not solve the inflation problem.  If, and it is a big if, this is the case going forward, my longstanding contention of a significant decline in the dollar versus commodities will likely play out.  As well, I would not want to own duration in the bond market, and while stocks might start out ok, recession does not pad profit margins, it impairs them, so stocks will have trouble as well.

In the meantime, let’s look at what happened overnight.  Friday’s continuation rally in the US saw some follow through in Asia, but it was truly a mixed picture there.  Japan’s Nikkei 225 (-1.8%) fell sharply as the yen rallied more than 1%.  Remember, about 40% of the Nikkei’s profits come from international sales and activity, and as the yen strengthens, it impairs those earnings in local terms.  Elsewhere, China (+0.3%) and Hong Kong (+0.8%) fared well, but Korea (-0.85%) suffered.  The other markets showed marginal gains.  In Europe, though, Spain (+1.0%) is leading the way higher although the rest of the continent is seeing much more limited gains, on the order of +0.25%, as a lack of new data or commentary seems to be allowing for a follow-on from the US session Friday.  UK shares are unchanged and so are US futures as traders await the big Powell speech on Friday.

In the bond market, Treasury yields are lower by 1bp, and we are seeing slightly larger yield declines in Europe, with sovereign yields down by between -2bps and-4bps.  Again, a lack of data and commentary means this is trading inspired, and not based on new information.  JGB yields rose 1bp, perhaps in sync with the yen’s rise overnight.

In the commodity markets, oil (-0.9%) continues to suffer as the slow growth, slowing demand story is the driver with absolutely no concern over the potential for an increase in supply tensions based on the ongoing wars in Ukraine and Israel/Gaza.  Meanwhile, gold (-0.8%) which closed above $2500/oz on Friday for the first time ever, is consolidating a bit and dragging silver (-0.5%) with it.  Interestingly, copper (+0.5%) is holding its own despite the slowing growth story.  That seems to be much more of a technical trading story than a fundamental one, although the long-term fundamentals remain quite bullish in my view.

Finally, the dollar is under further pressure this morning, falling against all its G10 counterparts and many of its EMG counterparts as well.  it should be no surprise that CNY (+0.3%) is stronger alongside the yen, but we also saw KRW (+0.85%) really benefit and almost every EMG currency, save MXN (-0.3%), which is today’s ultimate laggard.  If the story is turning to more aggressive US rate cuts, the dollar will continue its decline.

On the data front this week, there is not much other than the Jackson Hole symposium, but here it is for you:

TodayLeading Indicators-0.3%
WednesdayFOMC Minutes 
ThursdayInitial Claims230K
 Continuing Claims1881K
 Flash Manufacturing PMI49.5
 Flash Services PMI54.0
 Existing Home Sales3.92M
FridayNew Home Sales630K

Source: tradingeconomics.com

So, as you can see, other than Powell on Friday, and three other Fed speakers (Waller, Bostic and Barr), earlier in the week, there is not much to see.  My take is the rate cut narrative is building momentum and that we are going to see further pressure on the dollar until either the data indicates no cuts are coming, or we have a more significant risk-off event where people run to dollars to hide.

Good luck

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A Stock Jamboree

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Said Jay, there are two goals we seek
Strong job growth while prices are weak
And as I sit here
The way things appear
Come autumn, Fed funds we may tweak

The market responded with glee
Twas truly a stock jamboree
Plus, bonds joined the fun
And went on a run
The dollar, though, sank in the sea

At this point, the only question in market participants’ minds is whether the Fed will cut 25bps or 50bps in the September meeting.  Yesterday afternoon, as widely expected, the FOMC left rates unchanged and tried to offer a balanced view of the future, explaining that both of their dual mandate goals were normalizing.  Obviously, inflation, which has been their primary focus for the past two years, has been moving in the right direction and Chairman Powell reiterated that they are gaining ‘confidence’ that they will achieve their 2% target.  But this time, Powell spent more time describing the job market and how it was now coming into balance.  In other words, what had previously been a significant inflationary pressure in the Fed’s collective view, was now having less of an impact on prices.

At the press conference, Powell would not be pinned down on a September cut, although based on pricing in the Fed funds futures market, you would be hard pressed to believe that.  This morning, the market is pricing more than 28bps of rate cuts (a 13.5% probability of a 50bp cut) into the September meeting, so the key will be to watch how that probability of a 50bp cut evolves.  If we start to see hard data, like tomorrow’s NFP or CPI, in two weeks’ time, decline, I’m confident that the market will be calling for a 50bp cut before long.

In the end, the recent correction seen in risk asset markets seems to have been just that, a correction, and now the narrative is that there are blue skies ahead with lower rates to support things and the Fed is going to stick the soft landing.  This poet is less certain that the best case will obtain, but that’s what makes markets.

So, even though we have not yet heard from the third major central bank as I write (the BOE is due to announce in a few hours’ time), I don’t think that is going to impact the global narrative.  Let me start by saying that I believe they will cut rates in the UK as yesterday’s activities in the US make it all but certain a cut is coming here, and given the ECB, BOC and Riksbank have all cut already, they have plenty of company.  However, let’s recap where things are now and what the market narrative is now explaining to us all.

Policy normalization is the new watchword as we hear that the BOJ is normalizing policy by raising interest rates and tightening while the rest of the G10 are normalizing policy by cutting rates and ending activities like QT.  I guess the definition that the punditry ascribes to normal policy is, every country has the same interest rate!  In fact, I say that only half tongue in cheek, as there is some merit to the discussion.  While it is certainly true that global economies have evolved in greater synchronicity over the past decades, interest rate policy has always been based on the idiosyncrasies of each economic area.  For instance, money supplies and productive capacities differ widely amongst countries, so why should we believe that the “proper” monetary policy is the same level of interest rates across the board.  Of course, we shouldn’t, but for market participants, it is much easier if they have one target for everything rather than being forced to understand each economy in its own right.

But with that in mind, let’s recap where things currently stand around the major economies.

1.     US – economic activity is slowing, but the pace of that slowdown is very modest, at least based on the recent GDP reading.  Inflation is slowly receding but has not yet achieved the Fed’s target and the jobs market has, to date, held up reasonably well.  Of course, we will know more about that tomorrow.  On the flip side, the manufacturing portion of the economy has been the laggard, with PMI and regional Fed surveys pointing to subpar activity.  There seems to be a disconnect between the slowing economy and the roaring equity market, but markets have a life of their own.
2.     Europe – economic activity overall is modest with a reversal in the weak vs. strong players as Germany is the sick man of Europe and the PIGS economies are all faring far better.  Inflation here is a bit stickier than it seems in the US as evidenced by yesterday’s higher than expected readings and remains well above the 2% target here.  Most nations are seeing more substantial weakness in their manufacturing sectors, although for some (I’m looking at you Germany) it is self-inflicted based on insane energy policies driving energy costs much higher.
3.     Japan – recent growth signs have been quite poor with a negative GDP release just last week indicating things are not going well.  This has been accompanied by above target inflation, which while seeming to slow, is slowing very gradually.  In fact, this is the one place where the FX rate seems to really have had an impact, with the yen’s previous weakness adding to inflationary pressures and offsetting their very modest monetary policy tightening.  However, the combination of the BOJ hiking and the Fed seeming to promise a cut has led the yen to recoup nearly 8% over the past several weeks and now that USDJPY is below 150, I expect to see this move continue.  That should help ameliorate some of the inflation pressures, although it is not clear to me it will help economic growth.
4.     China – last night’s Caixin Manufacturing PMI was a disappointing 49.8, down two points and below expectations.  The indication is that economic activity in China remains hampered by the lack of consumer activity.  China’s long-term policy of mercantilism is running into its limits as nations around the world are unwilling to take their excess production freely, and the domestic economy remains in the doldrums, still suffering from the ongoing deflation of the property bubble.  While the PBOC did reduce interest rates recently, the fact that neither the Third Plenum nor the Politburo were willing to inject real stimulus into the economy indicates that things are going to remain lackluster going forward.

Arguably, the lesson from this recap is that economic activity is in a downtrend and that inflation is also in a downtrend, just a shallower one.  Policy makers around the world are struggling to find the right mix because oftentimes, the right mix means something politically difficult.  Net, I expect this process will continue and that we will see more and more efforts to turn around the economic trend while ignoring the inflation trend.

Ok, this has turned into more than I expected, so let’s be quick on markets today.  Yesterday’s Fed led to a huge tech sector rally in the US but that was not enough to help the rest of the world.  Despite that optimism, Japanese shares (-2.5%) were down sharply on the continued strength of the yen, while Chinese shares, in both Hong Kong (-0.25%) and the mainland (-0.7%) saw no love either.  In fact, the whole region was under water.  The same is true in Europe this morning with all the continental bourses lower on average by -0.65% or so after continued weak PMI data was released this morning.  The only exception here is the UK, where the FTSE 100 is now higher by 0.3% after the BOE, as I expected, cut rates by 25bps at 7:00am.  As to US futures, euphoria is still alive and they are all higher at this hour, just past 7:00.

In the bond market, yields are declining around the world led by Treasury yields which fell 10bps yesterday, although they have rebounded by 2bps this morning.  2yr yields also fell a similar amount so the yield curve’s inversion remains at -23bps this morning.  In Europe, yields also slid yesterday, albeit not as much as in the US and are a further 2bps lower this morning as they try to catch up.  The exception here is the UK, again, as 10yr Gilt yields are lower by 5bps this morning in the wake of the BOE cut.  JGB yields overnight fell 1bp, although given the move in Treasury yields, that gap has still narrowed substantially.

In the commodity markets, oil (+0.9%) continues to rally as fears over an Iranian retaliation against Israel grow with no clear idea where this will stop.  Consider, though, WTI remains below $80/bbl still, so right in the middle of its longer term range.  I imagine we could see a bump higher, but remember, OPEC has a lot of spare capacity, so if some countries are forced to stop producing, the Saudis can turn on the taps.  Gold (-0.4%) is backing off the new all-time highs it reached yesterday, but remains far above $2400/oz.  In fact, all the metals markets saw gains yesterday and this morning they are ceding some of those gains, but I don’t think this story has changed; if the Fed gets more aggressive, I expect these commodity prices to rise further.

Finally, the dollar is on fire this morning, rallying against everything but the Swiss franc right now.  The pound (-0.7%) is under the most pressure in the G10 after the rate cut, but we are seeing weakness everywhere else but Norway and Switzerland.  Even the yen, which had broken through the 150 level earlier this morning is now back below (dollar above) that level, although I expect there are further declines to come here in the dollar.  One other surprisingly large mover is CNY (-0.4%) which has given back more than half its gains from the activities last week involving the PBOC rate cuts and intervention.  Remember, if the yen continues to strengthen, the renminbi will be able to do so at a very gradual rate and maintain increased competitiveness vs. Japanese exports.

On the data front, this morning brings Initial (exp 236K) and Continuing (1860K) Claims, Nonfarm Productivity (1.7%), Unit Labor Costs (1.8%) and ISM Manufacturing (48.8).  Remarkably, there are no Fed speakers on the schedule, but I imagine they will not be able to keep quiet for long.  However, while there is a definite glow amongst investors, all eyes will turn to tomorrow’s NFP data, where a hot number will not be taken well, at least not at first, but if we print below NFP expectations, look for stocks to rock on a growing expectation of 50bps in September.  That will also hurt the dollar, which should retrace some of today’s gains.

Good luck
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New Shibboleth

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A second rate hike
By Japan has resulted
In strong like bull yen

 

Last night, Governor Kazuo Ueda and the BOJ raised their overnight call rate to 0.25% from the previous level of between 0.00% and 0.10%.  This move was forecast by several analysts but was certainly not the base case for most, nor what this poet expected.  However, it appears that the gradual slowing in inflation in Japan was not seen as sufficient and so they moved.  By far, the biggest reaction came in the FX markets where the yen jumped sharply, now higher by 1.5% compared to yesterday’s NY close.  A look at the longer-term chart of USDJPY below shows that at its current level just above 150.00 (obviously a big round number), the currency has reached a double support level based on its 50-week moving average (the curved line) and the trend line that starts from the time the Fed began raising interest rates in March 2022.

Source: tradingeconomics.com

Surprisingly, given the sharp move seen overnight, there has been virtually no discussion as to whether the MOF asked the BOJ to intervene and further push the yen higher (dollar lower) in concert with its recent strategy of pushing a market that is moving in its favor rather than fighting a market that is moving against its goals.  Regardless, the 150 level is going to be a very important technical support, and any break below may open up another 10 yen decline in the dollar.

What, you may ask, would lead to such a move?  How about the Fed?

The pundits are holding their breath
With “cut Jay” their new shibboleth
But will Chairman Powell
Now throw in the towel
On prices and channel Macbeth?

Of course, this afternoon, the big news is the FOMC meeting wraps up and at 2:00 they release their statement which is followed by the Chairman’s press conference at 2:30.  As of this morning, the probability of a cut today is down to 3.1% according to the CME’s futures market.  However, that market has a 25bp cut locked in for September with a further 10% probability of a 50bp cut then and is pricing in a total of 66bps of cuts by the December meeting, so, a bit more than a 60% probability of three 25bp cuts by the end of the year.  That pricing continues to feel aggressive to this poet as the data has not yet shown that the economy is clearly in trouble.  Remember, too, the Fed is always reactive, despite any of their comments on trying to get ahead of the curve.

Continuing our observations of mixed data, yesterday saw that home prices, as per the Case-Shiller Index, remain robust, rising 6.8% in May (this data is always lagging), but there is little indication that the shelter component of the inflation statistics is set to decline sharply.  As well, the JOLTs Job Openings data printed at a higher than expected 8.184M, indicating that there is still labor demand out there.  Finally, the Consumer Confidence number rose a touch more than expected to 100.3.  My point is there continues to be strength in many parts of the economy and prices are nowhere near declining.  Granted, this Friday’s NFP report will take on added importance as if the numbers there start to decline and Unemployment continues its recent trend higher, there will be far more urgency to cut rates.  Perhaps this morning’s ADP Employment report (exp 150K) will help clear up some things, but I’m not confident that is the case.

Interestingly, there are still a number of analysts who are clamoring for the Fed to cut today, claiming they can get ahead of the curve and stick the soft landing.  However, history has shown that the Fed lives its life behind the curve, and there is no indication that is about to change.

There is one other thing to consider, though, and that is the politics of the situation.  While the Fed is adamant they are apolitical and only trying to achieve their mandated goals, we all know that in order to even be considered to reach the FOMC as a named member of the committee, one needs to be highly political.  Does that mean that partisan politics enters the arena?  These days, it is almost impossible for that not to be the case.  

The current narrative on this subject is that a rate cut will help the current administration, and by extension the candidacy of VP Harris.  I’m not sure I understand that given inflation, which remains a major topic of conversation around the country, especially at the proverbial kitchen table, is so widely hated across the board.  The most interesting poll results I saw were that a majority of those questioned indicated they hated inflation far more than a recession.  This surprised the economic PhD set, but as inflation is an insidious cancer on everyone’s wellbeing, it is no surprise to this poet.  My point is that a rate cut now will do exactly zero to help support growth before the election, but it will almost certainly boost the price of commodities, notably energy and gasoline, and that will show up in inflation post haste.  Thus, does the narrative even make sense?  If Powell is truly partisan (and I don’t think that is the case), he would refrain from cutting rates until September as any impact, other than in financial markets, will not be felt until long after the election.  FWIW, I agree with the market there will be no cut today, but absent a major decline in the employment situation by September, I see only 25bps there.

Ok, a bit too long to start today, but obviously there is much of importance to understand.  So, let’s look at how markets have responded to the BOJ while they await the FOMC.  As earnings season continues, the tech sector in the US continues to struggle as evidenced by the sharp decline in the NASDAQ yesterday, although the DJIA managed to gain 0.5%.  In Asia, though, tech concerns were overwhelmed by the excitement of the BOJ’s action and the strength in the yen.  Perhaps the surprising thing is the Nikkei (+1.5%) rose so much given a strong yen generally undermines the index, but the rate hike boosted bank shares by 5% or more across the board.  And that strong yen was welcomed everywhere else in Asia with Chinese shares (Hang Seng +2.0%, CSI 300 +2.2%) and almost every regional exchange gaining real ground on the back of a less competitive Japan given the higher yen.

In Europe, most markets are much firmer as well this morning, led by the CAC (+1.4%) and FTSE 100 (+1.4%) although Spain’s IBEX (-1.0%) is lagging on uninspiring corporate earnings results.  I would contend these markets are being helped by that stronger yen as well, given Japan’s status as a major exporter.  Lastly, US futures are higher at this hour (7:20) after some better-than-expected results from chipmaker AMD, although MSFT’s numbers were less impressive.  Net, though, NASDAQ futures are up 1.6% this morning dragging everything else along for the ride.

In the bond market, Treasury yields continue to edge lower, down -1bp this morning and European sovereign yields are all lower by between -2bps and-3bps.  That is somewhat interesting given the flash Eurozone inflation data printed higher than expected at 2.6% headline, 2.9% core, but the market is clearly going all-in on the rate cutting narrative.  The big moves in this market, though, came in Asia with JGB yields jumping 5bps after the rate hike and the BOJ’s announcement they would be reducing their monthly purchases by 50%…OVER THE NEXT TWO YEARS!  They are not exactly rushing to tighten policy.  However, even more impressive was the -16bp decline in Australian 10yr bond yields after softer than expected inflation data overnight got the market thinking about rate cuts instead of the previous view of rate hikes being the next move.

In the commodity markets, things have really broken out.  Oil (+3.5%) is finally paying attention to the escalation of hostilities in the Middle East after Hamas leader Haniyeh was killed while in Iran.  While Israel has not officially claimed the act, that is the assumption and concerns are elevated that there will be a more dramatic response impacting many oil producing nations.  This has encouraged the rally in precious metals with gold (+0.4%) continuing its rally after a >1% gain yesterday, and support for both silver and copper as well.  Frankly, the copper story doesn’t make that much sense given the ongoing lackluster economic growth story, but with the metal’s recent sharp decline, this could simply be a trading bounce.

Finally, the dollar is all over the place this morning.  As mentioned above, the yen is today’s big winner, but we have seen strength in CNY (+0.25%) and KRW (+0.85%) as well, with both those currencies directly aided by yen strength.  Meanwhile, AUD (-0.5%) has responded to the quickly evolving rate story Down Under and is cementing its position as the worst performing G10 currency in July.  Not surprisingly, the commodity linked currencies are having a good day with ZAR (+0.6%) and NOK (+0.5%) both stronger, but after that, the financially linked currencies are not doing very much, so the euro, pound, Loonie and Swiss franc are all only marginally changed on the day.

In addition to the ADP and the FOMC, this morning also brings the Treasury’s QRA, although there is little interest in that report this time around as expectations remain that there will be no major change to the recent mix of debt, i.e., mostly T-bills.  We also see Chicago PMI (exp 44.5) and get the EIA oil data, although the latter will have a hard time competing with a pending war in the Middle East.

All told, not only has a lot happened, but there is also room for a lot more to occur before we go home today.  Quite frankly, I don’t see anything extraordinary coming from Powell, but the risk, to me, is he is more dovish than required and the dollar falls more broadly while commodity prices rise.  Keep your eye on that 150 level in USDJPY, as a break there can really get things moving.

Good luck

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Jay’s Motivation

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The Keynesian view of inflation
Claims growth is its major causation
If that is the case
Then given the pace
Of growth, what is Jay’s motivation?
 
Instead, ought he not be concerned
Inflation will soon have returned?
Or does he believe
That he can deceive
The market without getting burned?

 

Another week passed with another set of confusing data.  But more important than the data’s inconsistency is the inconsistency in the arguments made by those desperate for the Fed to cut rates.  For instance, former NY Fed president Bill Dudley wrote a widely read article for Bloomberg saying that he had suddenly become a convert and that the Fed needed to act this week and cut rates.  Granted, he wrote this article the day before the much hotter than expected GDP data was printed, but nonetheless, he had been a staunch hawk and changed his feathers.  And he is not alone, with a number of other high profile financial personalities (I’m looking at you Claudia Sahm) in the same camp.

But I would ask them the following: since you are strong proponents of Keynesianism which describes inflation as a direct result of strong growth and labor markets, given that GDP is running at 2.8% annualized, double Q1’s pace and above trend, and a federal government budget deficit that is approaching 7% despite that growth, and the latest PCE data showing that services inflation remains quite robust (the 6-month level has risen to 5.4%), why do you think the Fed should cut rates?  By your own thesis, inflation is more likely to rise than fall given the economic strength.  Alas, either no journalist will ask that question, or no Fed official will answer. 

At the same time, those analysts who have been calling for a recession in the near future, continue to dig through the better-than-expected data releases and find the weak points to make their case.  Here’s the thing, Powell and company cannot point to yet another subindex of the major data points and claim that is why they are cutting.  He remembers far too well his focus on so-called super core (core ex housing) with the expectation that housing was the problem and if he removed the part of the index that was rising, the rest of the index would be lower.  Alas for his finely tuned plans, that number continues to power along at 4.0% or higher.  He will not make the same mistake again and focus on some obscure view.  

At this point, there is certainly no reason for the Fed to act this Wednesday, and unless the economy essentially falls out of bed by September, it will be difficult to make that case as well.  This is not to say they won’t cut in September come hell or high water, just that if the economy proceeds as it currently appears to be doing, there will be no justification.  But just to put an exclamation point on the likelihood a cut is coming in September, this morning the Fed whisperer, Nick Timiraos, told us that is the case in his latest missive for the WSJ.

In addition to the Fed meeting this week, we also hear from Ueda-san and the BOJ on Tuesday night and Governor Bailey and the BOE on Thursday morning.  Given the near certainty that the Fed is going to remain on hold this week, arguably the BOJ is the far more interesting meeting, at least for financial market cues.  Remember, the narrative has been that the BOJ was finally going to start to “normalize” their policy, lifting interest rates above 0.0% and start to reduce their ongoing QQE program.  Now, this has been the story since last October, and while they did exit the NIRP stage back in March, there has been nothing since then.  Not only that, as I highlighted last week, inflation in Japan is already slowing with the current policy.  

In addition, the yen, while it has backed away from its recent highs (dollar lows) by about 1%, is far from its worst levels and appears to be trending slowly higher, exactly what they want.  I see no case for a rate hike here, although we will certainly hear about how they may modify their QQE actions going forward.  (As an aside, for those with JPY exposures, 152.00 is a very critical level in the market’s perception and a break below that level could well lead to a significant decline in the dollar.)

Lastly, the BOE is going to cut by 25bps.  Given that the ECB has already cut, as has Switzerland and Canada, they will not be able to hold out any further.  I don’t think we need any rationale beyond this to believe Bailey will act.

Ok, let’s look at the overnight market activities.  Friday, you may recall, US equities rebounded sharply from the short-term correction and Japanese shares (Nikkei +2.1%) followed right along, as did the Hang Seng (+1.3%) and almost every other major market in Asia save one, China (CS! 300 -0.5%) as there continues to be a distinct lack of progress on the economy there.  In Europe, the situation is mostly positive as both the DAX (+0.4%) and Spain’s IBEX (+0.6%) are rallying nicely but the French (CAC -0.1%) are suffering a bit, perhaps because of the seemingly constant mishaps regarding the Olympics and the nation’s infrastructure.  This morning, major internet connections were severed around the country, although backups are now working, which added to a dramatic blackout over the weekend and the high-speed rail terrorist arsonist attacks late last week.  But here at home, US futures are firmly in the green (+0.4%) at 6:15am.

In the bond market, euphoria is the story as virtually every major bond market has rallied with yields falling around the world.  Treasury yields are lower by -4bps while across European sovereigns, we are seeing declines of between -5bps and -7bps across the board.  Even JGB yields (-4bps) have fallen, perhaps another signal that the BOJ is unlikely to be acting this week.

In the commodity markets, oil (-0.3%) cannot seem to find any support of note despite a significant inventory draw last week and an escalation in events in the middle east over the weekend.  For the past year, oil has traded between $70/bbl and $90/bbl and we continue to trade in that range with no exit in sight.  We will need to see some very significant economic changes, either a sharp recession or a giant rebound in China, to break out of this range I believe, neither of which seems like a near-term phenomenon.  In the metals space, gold (+0.3%) continues to find support even after a sharp decline a couple of days last week, with spot hovering just below $2400/oz.  This morning, silver (+0.75%) is also rallying but copper (-1.1%) is in a sharp downtrend, despite the news that the workforce at the world’s largest copper mine, Escondida in Chile, is preparing to go on strike.  

Finally, in the currency markets, despite the lower yields everywhere and the generally positive risk environment, the dollar is higher nearly across the board.  Both the euro and pound are softer by about -0.2% and we are seeing the EEMEA currencies following suit with declines on the order of -0.4% across this bunch.  USDJPY is little changed this morning although CNY (-0.1%) is edging lower again after the PBOC’s recent efforts to prevent a sharp decline in the wake of their rate cuts.  Interestingly, the outlier this morning is NOK (+0.3%) despite oil’s decline and there is no obvious catalyst for this movement.  One other currency that is bucking this trend is AUD (+0.1%) which while not much higher this morning, given it has been falling sharply every day for the past two weeks, seems to have found a bottom.  That movement is highly linked to the JPY strength as AUDJPY is a favorite carry trade for many in both the institutional and retail spaces.  If USDJPY does break through that 152 level look for AUD to continue its decline.

On the data front, we know it is a big week, but here are the details:

TuesdayCase Shiller Home Prices6.6%
 JOLTS Job Openings8.03M
 Consumer Confidence99.5
WednesdayBOJ Interest Rate Decision0.1% (unchanged)
 ADP Employment149K
 Treasury QRA 
 Chicago PMI44.5
 FOMC Rate Decision5.5% (unchanged)
ThursdayBOE Rate Decision5.0% (-0.25%)
 Initial Claims236K
 Continuing Claims1860K
 Nonfarm Productivity1.7%
 Unit Labor Costs1.8%
 ISM Manufacturing49.5
 ISM Prices Paid52.5
FridayNonfarm Payrolls175K
 Private Payrolls150K
 Manufacturing Payrolls-2K
 Unemployment Rate4.1%
 Average Hourly Earnings0.3% (3.7% Y/Y)
 Average Weekly Hours34.3
 Participation Rate62.5%
 Factory Orders-3.0%
 -ex transport+0.3%

Source: tradingeconomics.com

Obviously, an awful lot to consume and digest this week with the central banks and then NFP.  In addition to all that, we have a significant amount of earnings data coming from some big names including Apple, Amazon, Meta and Microsoft.  Certainly, the strong expectation is for the Fed to remain on hold and prepare the market for a September cut.  That is already priced into the futures market, so much will depend on the tone of the statement and the press conference following the meeting.  As such, my sense is the real unknown is the BOJ early Wednesday morning, but I suspect they leave rates on hold.  If they do hike, I would look for USDJPY to break that key support level of 152, so that feels like the biggest risk heading into the week.

Good luck

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Ending Debates

Posted on by

There once was a banker named Jay
Who lived deep inside the Beltway
His words, when he spoke
Would sometimes evoke
A dovish response on the day
 
On Monday, we all got to hear
His views, and to some he was clear
Quite soon he’ll cut rates
Thus, ending debates
‘Bout ‘flation the rest of the year

 

While the market awaits this morning’s Retail Sales data (exp 0.0%, 0.1% ex autos), the focus for most traders and investors has been on Chairman Powell’s speech and discussion yesterday at the Economic Club of Washington DC.  The following headlines came from his prepared remarks and were highlighted all over the tape:

*POWELL: LAST THREE INFLATION READINGS DO ADD TO CONFIDENCE 

*POWELL: LABOR MARKET ESSENTIALLY NO TIGHTER THAN PRE-PANDEMIC 

*POWELL: JOB MARKET DOESN’T HAVE SLACK, ESSENTIALLY EQUILIBRIUM 

Then, following up in a Q&A, the money lines were these, “Now that inflation has come down and the labor market has indeed cooled off, we’re going to be looking at both mandates.  They’re in much better balance.”  

Not surprisingly, the market took this as confirmation that rate cuts are coming soon, although the futures market continues to price September as the likely first move.  While the meeting in 2 weeks has only a 9% probability priced in for a 25bp cut, looking at September’s pricing, 25bps are guaranteed and there are now some traders/investors looking for a 50bp cut, with that probability at 12.5%.  

Personally, I think there is a better chance of a July cut, especially if the PCE data next week are as soft as the CPI data were last week, than a 50bp cut in September.  My sense is that to get 50bps in September we would need to see the Unemployment Rate rise to 4.7% by that meeting with NFP pushing toward zero.  And while anything is possible, that seems highly unlikely in terms of the speed of the adjustment for those economic data series.  Other than the pandemic, even during deep recessions in the past, the rate didn’t rise that quickly.

As such, the market is now quite comfortable with the idea that the long-awaited initial rate cut will be here before the Autumnal equinox.  So, if that is the case, what does it mean?

One cannot be surprised that equity markets remain buoyant as we continue along the goldilocks trail of solid growth with slowing inflation.  Cutting rates into this environment will just add fuel to the equity fire.  There has been much made in financial discussions about the recent performance of small-cap stocks during the past several sessions.  It seems they have finally awoken from their deep slumber and have performed quite well, better even than the mega-cap tech names.  This has generated great excitement and we have seen several analysts raise their equity forecasts ever higher.  It seems that S&P 500 at 6000 is now a conservative view!

In the Treasury market, the yield curve has been slowly reverting to its more normal shape with 2-year yields falling more rapidly than 10-year yields.  This is the bull steepening that many had been anticipating, where yields overall decline, it’s just that the front end of the curve falls faster than the back.  History has shown that this type of movement typically foreshadows a recession, as the steepening accelerates when the Fed is slashing rates as the economy heads into a tailspin.  But maybe this time is different.  Ultimately, it can be no surprise that the yield curve is moving back to its normal shape of long-term yields higher than short-term yields.  After all, this inversion has been the longest in history.  I am just concerned that the speed of the onset of the coming recession may be much faster than most people assume.

As to commodity markets and the dollar, if the Fed is moving into a policy easing cycle, then commodity prices, especially precious metals and energy, ought to rally from here.  There may be a delay in industrial metals as a weak economy will weigh on demand there.  And the dollar will likely have a considerable down leg as well, although it will be tempered as central banks elsewhere around the world feel emboldened to be more aggressive with their own policy easing.

So, with that as a framework ahead of any potential future Fed actions, let’s look at what happened in the immediate wake of the Powell comments.  (As an aside, SF Fed President Daly also spoke yesterday and reiterated her concerns over the rise in the Unemployment Rate, indicating she was ready to cut.  Too, Chicago Fed president Goolsbee explained he was on the same page.)

Of course, given the Powell commentary, it is no surprise that US equity markets rallied yesterday with a new record high close from the DJIA although neither the NASDAQ nor S&P 500 could hold their record highs into the close.  Nonetheless, it was a strong day in the US markets.  In Asia, though, the picture was more mixed with the Nikkei (+0.2%) edging higher alongside a small move higher in USDJPY, and mainland Chinese shares (CSI 300 +0.6%) also gaining on hopes for some positivity from the Third Plenum.  But the Hang Seng (-1.6%) fell on fears of a Trump victory and the imposition of more tariffs on goods from there. The rest of the APAC space saw mixed reviews with some gainers (Taiwan, New Zealand, Korea) and some laggards (Australia, Malaysia, Singapore) although most of this movement was in small increments, 0.25%-0.35%.

European bourses, though, are having a tougher day as they are all lower on the session.  It seems that concerns over a Trump victory are manifesting themselves in concerns over European sales into the US or the imposition of tariffs here as well.  Adding to the misery, German ZEW data revealed a turn back down after several positive months, as concerns over the political situation in France and declining exports there weighed on the reading.  The upshot is that there is weakness everywhere, led by the CAC (-0.8%) in Paris and the IBEX (-0.8%) in Madrid.  (I think I wrote that exact sentence yesterday!). In the end, after a nice run as investors started to bet on ECB rate cuts, that story seems to be diminishing.  As to US futures, at this hour (7:30) they are modestly firmer, 0.2% or so.

In the bond market this morning, it appears that everyone around the world is excited about the possibility of Fed rate cuts as yields are lower across the board.  Treasury yields are down 6bps and European sovereign yields have fallen between 3bps and 5bps.  Even JGB yields slid 3bps overnight.  As has been the case for quite a while, the US yield story leads the global yield story.  If the Fed is going to start to cut, I expect that yields around the world are going to decline further, at least until inflation returns.

In the commodity markets, oil (-1.6%) is under pressure after weak oil demand data from China overnight undermined hopes that the Third Plenum would result in more government stimulus from the Xi government. This weakness is evident in industrial metals as well with both Cu (-0.65%) and Al (-1.0%) sliding further. However, precious metals are responding as one would expect to rate cuts, especially with inflation still around, as both gold and silver higher by 0.7% this morning, taking gold to new all-time highs.

Finally, the dollar continues to range trade overall with the DXY little changed on the day and hanging out just above 104, which happens to be its 60-year average!  While most currencies in both the G10 and EMG blocs are within +/-0.2% of yesterday’s closes, the one outlier is ZAR (+0.8%), which seems to be responding to some domestic plans to increase infrastructure investment in conjunction with private companies.

Other than the Retail Sales data mentioned above, there is nothing of note on the calendar today, although we will hear from new Fed governor Adriana Kugler.  At this point, I think it is becoming clear that the entire FOMC is on the same page; higher for longer is dead, long live the beginning of policy ease.  It is setting up to be a quiet session although I expect to see continues support for rate sensitive products like equities and precious metals.  The dollar, though, seems stuck as every central bank is ready to cut!

Good luck

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Unfair-ish

Posted on by

Well, Jay and the doves got their wish
As CPI data went squish
In fact, it’s not clear
Why cuts aren’t here
Already, it’s just unfair-ish
 
But something surprising occurred
‘Cause rallies in stocks weren’t spurred
But yields and the buck
Got hit by a truck
While gold was both shaken and stirred
 
Chairman Powell must be doing his happy dance this morning as the CPI data was the softest seen since May 2020 during the height of the Covid shutdowns.  Now, after four years of steadily rising prices, the Fed is undoubtedly feeling better.  One look at the chart below, though, shows that the inflation rate since the end of Covid was clearly much higher than that to which the population became accustomed prior to Covid.

 

Source: tradingeconomics.com

While the annualized data for both core and headline readings remains above 3.0%, there was certainly good news in that shelter and rental costs rose more slowly than they have in nearly three years.  However, for market participants, they are far less concerned over the whys of the soft reading than in the fact that the reading was soft and so they can now anticipate a rate cut even sooner than before.  As of this morning, the Fed funds futures market is now pricing a 92.5% probability that the Fed cuts in September and a total of 61bpsof cuts by the end of the year.  

In truth, I was only partially joking at my surprise they didn’t call an emergency meeting and cut yesterday. While the market is only pricing a 6% chance of a cut at the end of this month, I think that is a pretty good bet. Speaking of bets, the trader(s) who established that big SOFR options position earlier in the week is set to have a really good weekend!

To recap, we’ve had the softest inflation reading in 4 years and the market is anticipating the end of higher for longer.  As I have written consistently, my take is when the Fed starts cutting, the dollar will fall, commodity prices will rise, yields will start to decline, but if (when?) inflation reasserts itself, those yields will head higher.  And finally, stocks are likely to see support, but a very good point was made today that if prices stop rising, then so to do profit margins at companies and profits in concert.  Perhaps, slowing inflation is not so good for the stock market, even if it means that rates can be lowered.  Ultimately, there is still a lot to learn, and this was just one number, but boy, is everyone excited!

Did the BOJ
Take advantage of the news
And sell more dollars?

In the FX markets, the biggest mover, by far, was the yen, which at its high point of the session (dollar’s lows) had risen 4 full yen, or 2.5%.  The move was virtually instantaneous as can be seen in the chart below, and it is for that reason that I do not believe the BOJ/MOF was involved in the market.

Source: tradingeconomics.com

While I understand that the BOJ is pretty good at their jobs, it seems highly unlikely that the MOF made a decision in seconds and was able to convey that decision to Ueda-san’s team to sell dollars.  Rather, my sense is that since the short yen trade is so incredibly widespread as the yen has served as a funding currency for virtually every asset on the planet, the fact that the story about higher for longer may be ending led to instant algorithmic selling by hedge funds everywhere and a massive rally in the yen.  When the MOF was asked about intervention, Kanda-san, the current Mr Yen, gave no hint they were in and said only that people will find out when they release their accounts at the end of the month, by which time this episode will have been forgotten.  Remember, too, the yen has fallen, even after today’s rally, nearly 13% thus far in 2024.  It needs to rally a great deal further before it has any macroeconomic impact on Japan’s economy.  For my money, this was just a market that was caught long dollars and weak hands got stopped out, although Bloomberg is out with an article this morning claiming data showing it was intervention.  One thing in favor of the intervention story, though, is that this morning, USDJPY is higher by 0.6% and pushing 160.00 again.

And lastly, the story in China
Continues to give Xi angina
Domestic demand
Is stuck in quicksand
So, trade is his only lifeline-a
 
The other story that is on market minds this morning is about the Chinese data that was released last night.  The Trade Balance there expanded to $99B, much larger than last month and forecast.  A deeper look also shows that not only did exports grow more than expected but imports actually declined.  Declining imports are a sign of weak domestic demand, a harbinger of weak economic growth.  Later, they released their monetary data showing that loan growth, along with M2 growth, continue to slide as Chinese companies are reluctant to take on debt to expand.  While Xi’s government is pushing some money into the system, it is apparent that the collapsing property market remains a major obstacle to any sense of balanced economic activity in China.
 
Of course, this is a problem because of the international relation problems it continues to raise, notably with respect to charges of Chinese dumping of manufactured goods, and the proposed responses from both the US and EU on the subject.  While my crystal ball is somewhat cloudy, when viewing potential future outcomes of this situation it seems increasingly likely that both the US, regardless of the election outcomes in November, and the EU are going to impose tariffs and other restrictions on Chinese goods, if not outright bans.  Neither of these two can afford the social disruption that comes with domestic companies being forced out of business by subsidized Chinese competition.  While inflation looks better this morning than it did last month, its future is far less certain given this growing political attitude.
 
Ok, let’s see how markets have behaved in the wake of all the new information.  Arguably, the biggest surprise is that the US equity markets did not really have a good day with the NASDAQ tumbling -2.0% although the DJIA eked out a 0.1% gain.  Given the yen’s strength, it is no surprise that the Nikkei (-2.5%) fell sharply, and given the Chinese trade data, it is no surprise that the Hang Seng (+2.6%) rallied sharply.  But mainland shares were lackluster, and the rest of APAC was mixed with some gainers (Australia, India, New Zealand) and some laggards (South Korea, Taiwan, Malaysia).  European bourses, though, are all in the green as traders and investors there look to the increased odds of the US finally cutting rates, therefore allowing the ECB and other central banks to do the same, as distinct positives.  As to US futures, at this hour (7:00), they are unchanged to slightly higher.
 
In the bond market, after US yields fell sharply yesterday, with 10yr yields closing lower by 8bps, although they traded as low as 4.17%, a 12bp decline from the pre-data level, this morning, we are seeing a modest rebound with yields 1bp higher.  European sovereign yields are all firmer this morning as well as markets there closed before the US yields started to creep back up.  So, this morning’s 4bp-5bp moves are simply catching up to the US activity.  Lastly, JGB yields dipped 2bps last night as traders sought comfort in the decline in US yields.
 
In the commodity markets, yesterday saw a sharp rally immediately after the CPI print with gold jumping nearly $40/oz and back above $2400/oz, while oil had a more gradual rise, although is higher by nearly $1/bbl since the release.  This is all perfectly in line with the idea that the Fed is going to start to cut rates soon.  However, gold (-0.4%) is giving back some of those gains today.
 
Finally, the dollar, which fell sharply against all currencies after the CPI print, notably against the yen, but also against the rest of the G10 and most EMG currencies, is slightly softer overall this morning with both the euro (+0.15%) and pound (+0.3%) doing well and offsetting the yen’s weakness this morning.  Elsewhere throughout the G10 and EMG blocs the picture is far less consistent with CE4 currencies all following the euro higher although ZAR is unchanged as it suffers on gold’s weakness this morning. 
 
On the data front, this morning brings PPI (exp 0.1% M/M, 2.3% Y/Y) and its core (0.2% M/M, 2.5% Y/Y) although given yesterday’s surprisingly low CPI data and the ensuing market movements, it doesn’t feel like this number has the potential for much surprise.  After all, a soft reading would already be accounted for by the CPI and a strong one would be ignored.  We also see Michigan Sentiment (exp 68.5) at 10:00, but that, too, seems unlikely to shake things up.  There are no Fed speakers scheduled and really, the big thing today is likely to be the Q2 earnings releases from the big banks.
 
It has been an eventful week with Powell’s testimony being overshadowed by yesterday’s CPI data.  While the market is almost fully priced for a September cut, I think the best risk reward is to expect the Fed to act at the end of July.  Next week we hear from 10 Fed speakers, including Chairman Powell on Monday afternoon.  I would not be surprised to hear them start to guide markets to a July cut which would bring dollar weakness alongside commodity price strength.  As to bonds and equities, the former should do well to start, but as yesterday showed, and history has shown, equities tend to underperform when the Fed starts cutting rates.
 
Good luck and good weekend
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If Forecasts Ain’t True

Posted on by

Chair Powell repeated his views
That if Unemployment accrues
The time to cut rates
To meet their mandates
Could very well soon lead the news

Investors have taken this cue
And built up positions, beaucoup,
Designed for a peak
If CPI’s weak
Beware, though, if forecasts ain’t true

It is not clear to me why the punditry is more convinced this morning than they were yesterday morning that Chairman Powell and the Fed are now more focused on the Unemployment situation.  After all, Powell’s opening remarks in front of both the Senate on Tuesday and the House yesterday were identical, and everybody knew going in that would be the case.  But it seems, based on the commentary this morning, that suddenly things that were still blurry before became crystal clear.

Look, it can be no surprise that as the Unemployment Rate rises, the Fed is going to pay attention.  Not only is it part of their mandate, but it is also a touchpoint for politicians as they preen in front of their constituents.  But, in the end nothing has changed since Tuesday’s testimony when Powell highlighted that he and the FOMC were closely watching the evolution of the labor market as well as prices.

At least, nothing has changed on the policy front.  However, the market narrative, as is its wont, has suddenly turned to a far more bullish stance on fixed income in general, and on short-term rates in particular.  It appears that, not for the first time this year, there have been some very large options positions established in the SOFR market looking for a Fed funds rate cut sooner rather than later and a total of three cuts this year.  A quick look at the Fed funds futures market continues to show that the probability of a September cut remains just north of 71% with another cut likely by December.  As such, the fact that somebody is risking $2 million in premium on a third cut implies a great deal of conviction.  A key for this position’s success will be today’s CPI report as a benign outcome will very clearly drive more traders into the camp of more cuts this year.

So, let’s turn our attention to CPI.  Current median expectations are for a 0.1% M/M rise in the headline number, leading to a 3.1% Y/Y outcome and a 0.2% M/M rise in the core number leading to a 3.4% Y/Y outcome.  The broad story is the ongoing analyst belief that shelter costs are set to decline (although they have been incorrectly forecasting that for more than 2 years), along with the continued decline in used car prices and auto insurance, will more than offset any pesky things like food and energy costs rising.  This poet does not have an inflation model to tweak so I can only offer my lived experience, and that remains highly doubtful that prices have stopped rising.  But, the only thing that matters is the numbers, regardless of how we all feel about them, so we will be awaiting, with baited breath, to see if the BLS has determined if the pace of our cost of living has slowed.

As we turn our attention to the rest of the world, apparently everybody believes that to be the case, as risk assets are rising all over.  I cannot find an equity market anywhere that has sold off in the session with the Nikkei (+0.95%) rising to a new all-time high and the Hang Seng (+2.1%) rebounding smartly from yesterday’s levels.  The same is true throughout Asia with Chinese (+1.1%) and Australian (+0.9%) shares also having good days.  In Europe, the gains have been less impressive, on the order of +0.2% to 0.3%, but they are consistent as everybody followed yesterday’s strong US equity performance where all three major indices rose more than 1%.  While US futures this morning are tinged slightly red, the losses are tiny, less than -0.1%.  It seems that everybody is all-in on the idea that the Fed is cutting rates soon.

In the bond market, though, things are slightly different.  While Treasury yields have edged lower by 1bp this morning, all European sovereign yields are moving in the opposite direction, with rises of between 2bps and 3bps.  The inflation data that was released from the continent this morning certainly didn’t demonstrate a rebound, so this seems more akin to a trading response to recent yield declines.

In the commodity markets, oil prices (+0.3%) are continuing their rebound from yesterday after EIA data showed larger inventory draws than expected.  Precious metals markets are also benefitting this morning from the Fed story as the idea of rate cuts generally supports that sector.  The only laggards are industrial metals with both copper and aluminum under a bit of pressure today, but that is after a few solid sessions.

Finally, not surprisingly, the dollar is a touch softer on the idea that US yields may soon be declining.  While the bulk of the movement has been modest, it is fairly consistent with the euro and the pound both higher by 0.15% (the pound benefitting from somewhat stronger than expected GDP data this morning) while most of the rest of the G10 is little changed.  The one exception is NOK (-0.9%) which still seems to be suffering from yesterday’s softer than expected CPI data.  In the EMG bloc, the bulk of the movement has been for stronger currencies with the most notable, in my view, CNY (+0.2%) which has been steadily depreciating but has reversed course on the lower US rate narrative.  I maintain my view that if the Fed is prepping the market for cuts, the dollar has a good distance to fall.

In addition to the CPI data, we see the weekly Initial (exp 236K) and Continuing (1860K) Claims data at 8:30.  The Atlanta Fed’s Raphael Bostic speaks later this morning, but again, after Powell just opened the doors for easier policy based on the employment situation, I don’t foresee this having a big impact.

The risk today is that the CPI data is hotter than expected as everybody is lined up for a soft reading.  If the data is soft, look for the current trends to extend, so higher risk assets and lower yields.  But, if CPI prints higher than expected, there will be a very quick reversal of views, at least for the short run, and I expect we can see a pretty sharp correction, at least for today.

Good luck
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Not Yet Diktat

Posted on by

The punditry’s now all atwitter
That joblessness is a transmitter
Of lower inflation
Thus, Powell’s flirtation
With turning into a rate slitter

But so far, the confidence that
Inflation is falling toward flat
Has not yet arrived
And could be short-lived
So, rate cuts are not yet diktat

As expected, Chairman Powell’s testimony to the Senate Banking Committee was THE story of the day yesterday.  However, it was not that interesting a story despite scads of digital ink spilled on the subject.  What was everybody so excited about?  Well, here are some key quotes and you can be the judge.  In his opening remarks, he explained, “Elevated inflation is not the only risk we face,” and “The latest data show that labor-market conditions have now cooled considerably from where they were two years ago—and I wouldn’t have said that until the last couple of readings.”  Scintillating, I know!

What does it mean?  The quick and dirty is that the Fed has become a bit more evenhanded in their views that the employment side of their mandate may soon force decisions that conflict with the inflation side of their mandate.  So, if the Unemployment Rate continues to rise going forward, even if inflation does not continue its recent downward trajectory, the Fed may decide employment is now more important and respond.

Doves everywhere are clamoring for the Fed to cut before it’s too late and the labor market collapses.  Meanwhile, hawks will explain that at 4.1%, while that is higher than the recent past, the Unemployment Rate remains quite well behaved, especially in the context of NFP results that have averaged 222K over the past six months.

But we really know that this was a nothingburger because a look at markets showed that nothing happened.  The major equity indices all closed +/- 0.15% while 10-year Treasury yields were unchanged from the morning and higher by 2bps from Monday.  Neither did the dollar or commodities move in any substantial way from their early morning levels.   So, now Powell will speak to the House Financial Services Committee today, give identical testimony and fend off whatever inane questions they ask there.  But he was clear that there would be no indications of the timing of any policy changes and that is certain to be true today as well.

And truly, that was the entire session yesterday.  There was no data released and aside from Powell, nobody cared about what other speakers said.  And as you can see above, Powell didn’t really say that much.  So, let’s take a look at the overnight session to see if there was anything interesting at all.

In equity markets, the one place that is trying to hang with the US tech sector is Japan, where the Nikkei rallied another 0.6% overnight and is now higher by 30% this year, second only to the NASDAQ’s 34% rise.  While some of this is excitement about tech, I believe a larger proportion of the gains is due to the yen’s ongoing weakness as many of the companies in the index have their JPY earnings benefit greatly from their export sales.  Elsewhere in the time zone, though, equities were under modest pressure with Chinese, Hong Kong and Australian shares all sliding a bit.  The news of note here was Chinese inflation data, which showed limited price pressures as consumption on the mainland remains lackluster, at best.

Europe, however, is in a much better mood as all the major indices around the continent are higher this morning led by Spain’s 1.0% rise but followed closely by France (+0.9%) and Germany (+0.75%).  Here, too, there has been a lack of data, so I guess the narrative has become that despite the electoral outcomes, investors have overcome their concerns that the new governments will destroy their respective economies.  I guess the one truth is that the new governments will try to spend as much money as possible as quickly as possible, and so support economic activity.  Meanwhile, the recent pattern in the US, higher NASDAQ, lower DJIA and limited movement in the S&P is playing out in the futures this morning as well.

In the bond market, Treasury yields have slipped back 2bps overnight, trading at the same levels as Monday, but there has been a much more aggressive bond rally in Europe with sovereign yields falling between 6bps and 9bps this morning.  It appears that investors are counting on the Fed to maintain its inflation fight, thus helping reduce global inflation pressures, and are responding to declining inflation from China as a rationale to add duration to their portfolios.  While the direction of travel is no surprise given the Treasury yield decline, it is a bit surprising the movement is this large.

In the commodity markets, oil (-0.2%) continues under pressure as the combination of relief that Hurricane Beryl had limited impacts and the potential for a cease-fire in Gaza have oil traders questioning the recent price action.  Arguably, a bigger concern is that slowing economic activity may begin to reduce demand, but that is not the main story today.  In the metals markets, both gold and silver are edging higher this morning while copper is essentially unchanged.  I continue to believe that the Fed is going to be the key driver in this space as if they do cut rates sooner than currently forecast, it seems likely that commodity prices will rise while the dollar declines.

But the dollar is not yet declining in any meaningful way with the DXY still trading above 105.00.  The big outlier today is NOK (-0.95%) which is not only suffering on oil’s recent declines but is also responding to this morning’s inflation data which showed more significant progress on returning it to target.  Core inflation printed at 3.4%, down from 4.1% last month and below the 3.6% estimates.  This has encouraged traders to believe the Norgesbank is going to cut rates sooner than previously expected, hence the krone’s decline.  As to the rest of the G10, NZD (-0.9%) is also under pressure as the RBNZ was less hawkish than anticipated last night, although they did leave rates unchanged.  After those two, though, the G10 is dead.  One thing to note is that USDJPY is back at 161.50, just a few pips below the most recent dollar highs seen last week, although, given the very calm nature of the move, we have not heard much from the MOF on the subject.

As to the EMG bloc, MXN (+0.45%) is continuing its rally after yesterday’s higher than expected CPI data from south of the border has traders looking for continuing policy tightness, pushing back any thoughts of an early ease.  Elsewhere, ZAR (-0.4%) continues its wild back and forth, so much so that it is difficult to pin any fundamentals to the movement.

There is no data of note today so all eyes will be on Chairman Powell when he testifies at 10:00 to the House.  In addition to Powell, we will hear from Governors Bowman and Cook as well as Chicago Fed president Goolsbee.  But really, can anything they say overshadow Powell?  I think not.

It is shaping up as another dull day as it seems unlikely Powell will tell us anything new.  As such, I would look for a quiet session as we all await tomorrow’s CPI data.

Good luck
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Some Mystique

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The Chairman is ready to speak
To Congress, and there’s some mystique
Will he indicate
The Fed’s favorite rate
Is likely soon in for a tweak?
 
Or will Chairman Powell explain
Inflation continues to drain
The ‘conomy’s health
And with it the wealth
He’s garnered through much of his reign

 

With recent elections behind us, market participants now turn their attention to Chairman Powell and his testimony today before the Senate Banking Committee and tomorrow before the House Financial Services Committee.  Of course, all eyes and ears will be searching for clues that the recent spate of softer than expected economic data has been sufficient to allow him, and his FOMC brethren, to gain the necessary confidence to cut the Fed funds rate.  Recall, to a (wo)man, every speaker has indicated that things were looking pretty good, but that they needed to see several months of this type of economic data before acting.

Lately, the punditry has become far more vocal about the possibility of a recession, with a number of well-known analysts claiming we are already in that state.  They point to the employment situation, notably the discrepancies between the establishment and household surveys.  Their argument revolves around the idea that the number of people working continues to decline despite the claim that there are more jobs being created.  It is true that job growth has been driven by an increase in part-time work, so this is not impossible.  And it is also true that when part-time work is ascendant, it typically signifies a weaker economy.

These same pundits point to the discrepancy between GDP and GDI (Gross Domestic Income) which ostensibly measure the same thing from different sides of the ledger.  Over the past year and change, as can be seen from the below chart, GDP has been growing at a faster rate than GDI with the difference between the two now at 2.3% of GDP.  

Source: St Louis Fed FRED data base

Putting that in context, the most recent Atlanta Fed GDPNow forecast for Q2 2024 has fallen to just 1.5% annual growth.  The implication is that GDP growth may well be negative.  Over time, these two measures get revised so that they are the same, but this particular discrepancy is both wider than normal and has been ongoing for a relatively long time in the history of the two.  Something is amiss and many pundits believe that the result will be GDP will be revised lower to match GDI rather than the other way around.  In other words, GDP growth is slower than reported and the chances we are currently in a recession are greater.

Of course, the other side of the story is also widely believed by other pundits who point to the consumer, which as evidenced by yesterday’s Consumer Credit data, continues to spend aggressively.  They also rely on the continued growth in the NFP data as a key indicator of economic activity and remain confident that the economy is simply in a slow patch during a continued growth period.

Now, it seems to me that the Fed are likely rooting for a bit more aggressive economic slowdown as that would give their models the signal that inflation is well and truly under control.  Perhaps Chairman Powell will give us those hints this morning, although he will certainly not explain that outright to the Senate.  (The one certainty from this morning’s testimony is that certain Senators from the Northeast are sure to rail at the current level of interest rates and berate Mr Powell for not having cut them already.)  In any event, that is really all we have on the calendar today, and likely the biggest news until Thursday’s CPI release.  After all, tomorrow’s House testimony will be identical by Powell, although we can look forward to even stupider questions from the likes of Representatives Maxine Waters and Ayanna Pressley.

And so, to markets.  Yesterday’s lackluster US session has seen a mix of results elsewhere in the world.  In Asia, the Nikkei (+2.0%) rallied sharply to new all-time highs, on the back of tech share enthusiasm and the AI story as well as the still weak JPY.  While the BOJ is slated to meet later this month, there is no clarity as to whether they will tighten policy given the still mixed data from Japan.  As well, Chinese shares (+1.1%) and Australian shares (+0.9%) both had solid performances although the Hang Seng was unable to gain any traction and was unchanged on the day.

In Europe, all is red this morning, led by the CAC (-0.8%) as it seems investors are beginning to understand that the electoral outcomes may not have been net beneficial for both the French and UK economies.  While the two nations have different issues (no leadership in France, a socialist one in the UK) I fear that both nations will have manifest economic problems going forward when it becomes clear that increased spending is unaffordable.  But for now, absent any additional data, investors are lightening up on exposures there.  US futures, though, are edging higher at this hour (8:00).

In the bond markets, yields are starting to turn higher again despite some lackluster economic data.  Treasury yields are higher by 2bps and across the UK and Europe, yields are higher by 3bps to 4bps universally.  This means there have been no changes to the spreads of OATs to Bunds, but it may not be that welcome overall.

In the commodity markets, oil (-0.4%) remains under pressure as concerns over US production being reduced by Hurricane Beryl have diminished now that wind speeds have fallen after landfall.  It did not impact the offshore drilling significantly.  As to metals markets, after a rough day yesterday, this morning both precious and industrial metals are little changed overall, arguably awaiting the next key catalyst, whether that is from Powell or CPI or something else.

Finally, the dollar is a bit firmer this morning across the board.  Both the euro (-0.15%) and the pound (-0.15%) have performed surprisingly well lately given the political backdrop.  Perhaps that is a hint that politics is not necessarily a key short-term driver of FX rates.  However, today, along with the rest of their G10 brethren, they are under pressure.  In the EMG bloc, ZAR (-0.6%) continues to demonstrate the greatest amount of volatility amongst the most traded currencies and is under pressure alongside metals prices.  As well, both HUF (-0.3%) and CZK (-0.4%) are showing their high beta response to the euro’s weakness.  However, today appears very much to be a dollar day, not a currency day.

The NFIB Survey was released at a better than expected 91.5, although that level remains in the lowest decile of readings in the history of the series.  In addition to Powell, we hear from Vice-chair for supervision Barr as well as Governor Bowman during the day, but really, it is all about Powell.  Personally, I doubt he tells us anything new and do not expect him to hint strongly at a rate cut coming soon.  However, if he does, look for the dollar to decline sharply.

Good luck

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A Shocking Surprise

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On Wednesday the data was dreck
On Friday, twas more of a wreck
The read’s now that growth
Is set for more slowth
Will this break the Fed’s bottleneck?
 
Meanwhile, in a shocking surprise
In France, tis the Left on the rise
But no party there
Is willing to share
Their power and reach compromise
 
And while day-to-day matters greatly
The populists, worldwide, are lately
Ascending to power
And ready to shower
Their voters with cash profligately

 

This morning, the world is a very different place than it was when I last wrote.  Broadly speaking there are three key stories of note; US data was much weaker than expected, the French election surprised one and all with the coalition of hard-left parties winning the most seats, although no group is even close to a majority of the French parliament, and the questions over President Biden’s capacity to remain on the job, let alone his ability to be president for the next four years, have been coming fast and furious from the mainstream media, many Democrats in Congress and the Democratic donor base.

So, let’s address them in order.  On the US data front, arguably the best release was the Trade Balance printing at a slightly smaller deficit than forecast by the Street.  Otherwise, ISM Services was miserable at 48.8, Factory Orders fell -0.5%, -0.7% ex Transport, and Initial and Continuing Claims both rose to new high levels for the cycle.  And that was just Wednesday.  On Friday, while the headline NFP number did beat forecasts, once again, there were major revisions lower to the past 3 months, -111K, the Unemployment Rate rose to a new high for the cycle at 4.1%, its highest level since November 2021 and a continuation of the recent uptrend in the data.  A look at the chart below seems to show a defined trend higher in the Unemployment Rate, and as I explained last week, this is a statistic that tends to have momentum once it gets going.  I would argue this number is going to continue to climb higher as the year progresses.

Source: tradingeconomics.com

As well, the biggest piece of the report was an increase of 70K Government jobs, compared to just 136K Private sector jobs and a loss of -8K in Manufacturing.  The one thing we know is that government jobs do not add to economic growth as they are the least productive of all.  

The upshot is that based on the data from Wednesday and Friday, the story of still strong growth in the US has clearly been called into question.  Will Powell, who testifies before Congress this week, pay homage to the weaker data and hint that perhaps higher for longer has reached its sell-by date?  While this is only one set of data, and he has been adamant that he needs to see several months of data, the market is becoming more convinced that a September rate cut is coming as the Fed funds futures probability of that cut has risen to 75%.  It should be an interesting week given both the CPI release and the Powell testimony.

On to the French and what was truly a shocking outcome, at least on one level.  After the first-round last week, the abject fear by the press in France, and all of Europe, of the idea that a right-wing government could come to power in a key European nation resulted in the numerous parties on the Left working with President Macron’s centrists to try to prevent any such thing from happening.  As such, they strategically pulled candidates from different seats in order to prevent splitting the vote and allowing Marine Le Pen’s RN party from achieving a majority.  And they were effective in that.  Alas, they now have a completely unworkable setup where no party has anywhere close to a majority and so passing any legislation will be nigh on impossible.  

Jean-Luc Melenchon, the Left’s most well-known proponent, and leader of a sect called France Unbowed, has declared that he wants his party’s agenda implemented full-on.  That means reducing the retirement age, raising wages and establishing price controls on power and energy as well as expanding wind and solar power.  Of course, the math on that won’t work, even if they raise taxes, but that certainly never stopped a populist once in office.  

Interestingly, while on the surface it would have been easy to conclude that French OATs would see yields rise vis-à-vis German Bunds as fears of larger government deficits build, that has not yet been the case.  In fact, this morning, yields across Europe are little changed as bond traders and investors seem to be ignoring the situation.  The rationale here is that given no group has a majority, the probability of having any party’s wish list implemented by parliament is vanishingly small.  The most likely outcome is a year of muddling through, with no decisions of any substance made and another election held next summer.  (By law, President Macron must wait one year after an election to call a second one.)  In fact, it will be very interesting to see how a prime minister will even be elected in parliament as it seems unlikely that any individual will have support of a majority of the chamber. 

As to the other potential impacts of this election, neither French equities nor the euro have shown any substantive movement as traders in both these spaces see the same situation, a very low probability of any substantive policy changes given the lack of parliamentary leadership.  Ultimately, while the political ramifications in France are large, the economic ones are not as obvious yet.

This is different than in the UK, where Keir Starmer and his Labour party swept to victory as widely expected.  In the UK, Labour runs the show now and so will be able to implement whatever policies they deem appropriate.  So far, there has been little in the way of concern demonstrated by market participants for UK assets either, but I fear the risk here is greater as the policy prescriptions that Starmer favors are likely to have a much larger negative economic toll.

Finally, in what must be THE most surprising aspect of the presidential election cycle in the US, former President Trump is NOT the major topic of conversation.  Rather, in the wake of the debate 10 days ago, the only topic is President Biden’s fitness for office now, and in the future.  This is certainly not a good look for the US, especially with a key NATO meeting this week in Washington D.C., but it is the current situation.  Thus far, US risk assets have ignored all this, arguably because the fiscal spending spigot has not been turned off.  But it is not hard to imagine that there are myriad problems ahead as Secretary Yellen tests just how many bonds the US can issue and still find buyers.

So, with all that remarkable news in our memory banks, let’s look at how markets are behaving this morning and what happened overnight.  Ironically, it seems Asian investors are the ones most upset by the European elections of last week as equity markets throughout the time zone fell.  The Hang Seng (-1.55%) was the laggard, although China (-0.85%) and Australia (-0.8%) also performed quite poorly and the Nikkei (-0.3%) was a star by comparison.  There was very little in the way of economic data to drive things here, so this seems merely to be part of the usual ebb and flow of markets.  The real surprise, though, is in Europe where equity markets are higher across the board.  Despite the pressures for more spending and higher taxes that will come from both France and the UK, the CAC (+0.45%) and the FTSE 100 (+0.3%) are nonplussed by the situation.  In the UK, as laws are implemented, I expect there will be a bigger reaction, but in France, perhaps the view that there is gridlock which will prevent any new legislation of note, means equities can run higher.  As to the US, futures markets at this hour (7:00) are basically unchanged.

As mentioned above, bond yields throughout Europe have been limited in their movement while Treasury yields have rebounded 2bps from last week’s declines.  While I was out, the weak data certainly encouraged bond investors to increase allocations as visions of a Fed rate cut grow.  For now, the bond markets are not signaling any concerns over the electoral outcomes.  My take is that may be appropriate for France and the continent, but I would be wary of UK Gilts given the likelihood of a downturn in the fiscal situation as more spending is implemented by parliament.

In the commodity markets, the end of last week saw sharp rallies in the metals markets, perhaps on those fears of a RN electoral victory in France, or perhaps on expectations of quicker Fed rate cuts, but this morning, commodities across the board are softer, with oil (-1.3%) leading the way, although WTI remains well above $82/bbl.  As to the metals, both precious (Au -0.7%, Ag -0.7%) and industrial (Cu -0.2%, al -0.1%) are giving back some of those gains.

Finally, the dollar is somewhat higher than it closed on Friday, although not very much.  In the G10, NOK (-0.5%) is suffering on oil’s decline which has dragged SEK (-0.4%) along with it.  The yen (-0.1%) which fell to near 162 vs. the dollar last Wednesday recouped some of those losses into the weekend but seems to have bounced with 160.00 now showing technical support in USDJPY.  In the EMG bloc, HUF (-0.8%) is the laggard as despite a lack of data, it seems markets are looking at the right-leaning politics of PM Orban and see continued friction between Hungary and the rest of the EU, specifically when it comes to subsidy payments.  KRW (-0.5%) is softer as the government’s efforts to expand trading hours in the currency have not yet borne fruit although it is still early days.  They are trying to improve onshore currency trading in order to allow more convertibility for equity investors and thus get Korean stock markets included in more global indices.

On the data front, while the calendar is not packed, it is impactful.

TodayConsumer Credit$10B
TuesdayNFIB Small Biz Optimism89.5
 Powell Testimony 
WednesdayPowell Testimony 
ThursdayInitial Claims240K
 Continuing Claims1860K
 CPI0.1% (3.1% Y/Y)
 -ex food & energy0.2% (3.4% Y/Y)
FridayPPI0.1% (2.3% Y/Y)
 -ex food & energy0.2% (2.5% Y/Y)
 Michigan Sentiment68.5
Source: tradingeconomics.com

In addition to Powell, 5 other Fed speakers are slated, but clearly all eyes will be on Powell.  And the CPI reading.  After last week’s soft data, there is a growing expectation that price pressures are going to fall back further and allow the Fed to cut rates.  Certainly, if CPI prints soft, I expect to see a rally in risk assets, but we must wait to hear Powell’s spin ahead of those numbers.

Net, the market is seemingly turning toward a more dovish approach with visions of rate cuts coming fast and furious once they get started.  That seems excessive to me, but for now, it is hard to like the dollar’s status as rate cut expectations build, especially given the market has ignored potential problems elsewhere.

Good luck

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