Tag Archives: #regimechange

The Tariff Watusi

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Undoubtedly, most are confused
And many portfolios bruised
The problem I fear
Is throughout this year
Both bulls and bears will be contused


Right now, it’s the tariff Watusi
With rules that seem quite loosey-goosey
So, traders are scared
While pundits declared
The president’s just too obtuse-y


But will volatility reign
All year with the requisite pain?
Or will, as Trump said
When looking ahead
The outcome be growth once again?

(Before I start, “Ball of Confusion” is brilliant and timeless.  But isn’t Billy Joel’s “We Didn’t Start the Fire” covered and updated by Fall Out Boy, really the same song for a different generation?) Now, back to our regular programming.

  • Tariffs are a tax.  So, say seemingly all the most credentialed analysts and economists around.  
  • Tariffs are inflationary.  So, say many of these same analysts and economists.  
  • Ergo, taxes are inflationary.  So, say…well none of the credentialed analysts and economists.  (H/T to Alyosha for highlighting this idea last week.)  

But it is important to recognize this dichotomy as we listen to the many pundits and analysts who are now telling us that a recession is coming, if not already here, and the world is ending.  It seems to me if you cannot recognize this connection then your views may be colored by something other than strict logic.

We are experiencing a complete regime change in both financial markets and economic outcomes around the world and as old as I am, the last time something like this occurred was long before I was born.  I am very wary of any analyst who demonstrates any certitude in their views at this point.  Frankly, I am more inclined to listen to historians than economists, as they have potentially studied previous regime changes.  Alas, I have not so I am reliant on those who I read.

The current confusion remains over tariffs, their implementation and their impact.  To me, the key point that is missing in most of the tariff discussions is the elasticity of demand for any given product.  If something is highly inelastic and tariffs are added, then the price of that item is very likely to rise.  However, if something has very elastic demand, then a tariff will do one of two things, either the producer will absorb the cost or the volume of sales will drop dramatically, but any price rise will be constrained.

I highlight this because the weekend’s ostensible pause in tariffs on electronic goods from China is the latest discussion point.  It strikes me that under the thesis tariffs are inflationary, then inflation forecasts and expectations should now be declining.  But I haven’t seen that yet.  In the end, though, I don’t believe anybody really knows how things will evolve from here, although I believe the end goal is becoming clearer.  

It appears that President Trump’s goal is seeking to isolate China from much of the developed world.  He wants to create a situation where nations declare they are either with the US or against the US when it comes to economic relations.  I read this morning that 75 nations are in negotiations with the US regarding tariff reductions.  Given that, by themselves, the G10 represent nearly 50% of global GDP, even not knowing which nations are negotiating, the group almost certainly represents upwards of 70% or more of the global economy.  

I would contend it is still very early days with respect to the results of President Trump’s actions.  There is no question he has unleashed a certain amount of chaos in the government and in markets, but I don’t believe he is greatly concerned by that, and in fact he may welcome the process.  Regime changes are always messy, and this one is no different.  Be nimble.

Ok, let’s look at how things behaved overnight.  Friday’s US equity rally was followed by strength throughout most of Asia (Japan +1.2%, Hong Kong +2.4%, China +0.2%, Korea +1.0%, India +1.8%) with Taiwan (-0.1%) the true laggard in the region.  Clearly the tariff reprieve, even if temporary, was welcomed.  In Europe, too, the gains are strong and widespread with the DAX (+2.3%) leading the way but the rest of the Continent and the UK all up at least 1.8%.  And at this hour (6:30) US futures are higher by around 1.0% as well.

But let’s keep things in perspective.  The below chart of the S&P 500 over the past 20 years can help you understand the magnitude (or lack thereof) of the recent decline.  Yes, the index is lower by about 12% from the all-time highs set in February, and yes, uncertainty is rife.  But if you ever wanted to understand what has happened since the Fed’s response to the GFC led to the financialization of the entire economy, the latest minor dip is being described as catastrophic by the punditry.  It’s not!

Source: multpl.com

Next, the Treasury bond market has been the focus of a great deal of angst lately.  Once again, these same analysts and economists claim the world is ending because yields have risen over the past week.  I grant the movement has been sharp, but my experience tells me that when a market as liquid as 10-year Treasuries moves this sharply, it is a position liquidation that is driving the move.  In fact, both the 10-year and 30-year auctions last week seemed to have gone quite well, with strong demand.  So, I am not of the opinion the bond market is about to collapse, nor do I believe that China is liquidating their Treasury holdings.  Rather, hedge funds carrying significant leverage and being forced to unwind seems the most likely culprit here.  Too, remember that 10-year yields are right in the middle of their range for the past six months at 4.43% (-6bps today).

Source: tradingeconomics.com

In fact, European sovereign yields are also retreating this morning led by Italy and Greece (-9bps) with German bunds (-4bps) the laggard of the session.  With equity markets around the world rallying, it doesn’t appear this is safe haven buying.  However, I do believe that there are many investors who are pushing at least some of their equity portfolios into fixed income amidst overall uncertainty.

Turning to commodities, oil (+1.25%) seems to have found a bottom, at least in the short-term, just below $60/bbl.  While a recession doesn’t necessarily drive inflation lower, I am very comfortable with the idea that it reduces demand for energy and oil prices can slip.  Is the recent move a harbinger of recession?  I think there is too much noise to discern the signals the market is giving us right now, although a recession, which has been long awaited by many analysts, certainly seems possible.  

As to the metals markets, while both gold (-0.7%) and silver (-0.3%) are a bit softer this morning, one need only look at their performance in the past week (both higher by more than 7%) to recognize that there is a great deal of growing demand for precious metals.  Dr Copper (+0.9%), like oil today, is not indicating that a recession is coming as it, too, rose 7% last week and is higher by 15% YTD.  Again, there is a lot of noise to get through to find the signal.

Finally, the dollar, is lower again today and is back at levels last seen…in September 2024.  And before that in July 2023 and March 2022.  In fact, if you look at the chart of the DXY below, I challenge you to show me that this decline was more dramatic than any of the three other major declines we have lived through in the past 3 years.

Source: tradingeconomics.com

Net the dollar has declined by about 10% since its recent peak in February, not insubstantial, but not unprecedented by any stretch.  In fact, over the long-term, the dollar is within spitting distance of its long-term average, which as measured by the DXY is about 104.  Looking at individual currencies, there is a strange grouping of currencies that have fallen vs. the greenback this morning, BRL (-0.85%), TRY (-0.5%), CHF (-0.5%) and CNY (-0.4%).  Given the pause in tariffs on Chinese electronic goods, CNY is confusing, as is CHF, which might imply havens are out of favor (but then why is JPY stronger?).  TRY is its own case and BRL is quite confusing.  Commodity prices have held their own or risen lately, and BRL is nothing, if not a commodity currency.  I need to search further here.  Perhaps we are seeing some carry trades being unwound.

I apologize as once again my Monday missive has grown too long for comfort.  I will highlight the data tomorrow with Retail Sales on Wednesday as the most important data release this week and the BOC and ECB meetings on Wednesday and Thursday respectively with the market looking for no change and a 25bp cut respectively.

The world is a messy place right now, with armed conflict now being joined by economic conflict.  Opinions are hardening along political lines, and I don’t see how this changes in the short run.  If you are managing risk, maintain your hedges, even if they seem expensive.  There are too many opportunities for large movements that can be costly.

Good luck

Adf

A New Boogeyman

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Confusion today is what reigns
As no pundit clearly explains
Why previous claims
Have gone up in flames
And how much more pain still remains
 
They still blame the Bank of Japan
With spoiling their well thought out plan
And too, yesterday
When bonds went astray
It gave them a new boogeyman

 

Yesterday started out so well for all those who were convinced that it was the BOJ’s surprising and extreme actions last week that led to an unwarranted selloff in stocks and other risk assets.  First off, the BOJ, via one of its members Ichida-san, basically apologized for their actions and said that they would not be making any other changes after all.  That led to a rally in equities and a sell-off in bonds as risk assets were suddenly back in favor.  Alas, by the end of the day, that was no longer the case.

But let’s look at what the BOJ actually did last week.  On the interest rate front, they raised their base rate to 0.25% and regarding their balance sheet, they indicated they had a plan to slow down its growth at a very gradual pace.  Remember, they did not say they were going to sell JGBs, they said that by 2026 they would be buying half as many JGBs as they do today.

Also, let’s remember that inflation in Japan is currently measured at 2.8%, so the base rate remains deeply negative in real terms.  I understand the signaling impact of what they did as any change in the status quo while there is a significantly leveraged market can have major impacts.  And that is what we saw during the past week.  It is also important to remember that given the length of time that the Japanese have maintained their ZIRP/NIRP monetary policy, the opportunity for very large institutions to build up very large positions was, to be succinct, very large.  The chart below shows for just how long Japanese interest rates have been near zero, more than twenty years.

Source: tradingeconomics.com

My point is that Japanese investors have been seeking alternative opportunities for an entire generation.  As well, the concept of the carry trade has been in place for that same amount of time.  It will take a long time for these ideas to be changed and the positions along with them.  Now, according to a Bloomberg article, JPMorgan’s analysts claimed that three-quarters of the carry trade has already been unwound.  And maybe they are right about that.  But I assure you that three-quarters of Japanese investors have not adjusted their positions in the fixed income market.  We have not come to the end of this road.

So, analysts found another cause for yesterday’s negative outcomes, the 10-year bond auction.  It turns out that investors are seeking more yield than the market had anticipated ahead of the auction.  This led to a 3 basis point tail, meaning that the auction cleared at a yield, 3.96%, 3 basis points higher than traders were pricing ahead of time (typical 10-year tails are well less than 1bp.)  There were less bids than anticipated, and generally this is not a good story for Secretary Yellen and the Treasury.  The story that circulated was that the reason stocks fell in the afternoon was the weak auction.  Alas, the timing of that does not make sense.  Equity markets had already given back their morning gains before the auction results were announced and were lower on the day at 1:00pm.  But narrative writers need a story, and that was a good one.

So, what really happened?  Who knows?  But FWIW this poet has seen enough market action during his career to recognize that while fundamentals matter in the long-run, daily changes are often completely random, or at least seemingly so.  Large orders can drive markets, especially when liquidity is lower because of holiday schedules and the time of year.  And lately, the combination of algorithmic trading and extreme retail speculation will also move markets in surprising directions.

I believe that we remain in a period of change.  Monetary policies around the world are adjusting to the realities of inflation remaining stickier than policymakers want to believe.  In addition, the political cycle continues to be difficult to forecast, notably in the US, with market perceptions of very different economic policies to be implemented depending on the next US president.  And finally, I believe the best way to describe the global economy is that it is in transition.  After a decade or more of easy money policies around the world, as those policies start to change, they impact different segments of the economy at different rates.  This means that some parts of an economy can be in recession while other parts can be doing fine.  And that gives rise to confusing data with no broad trend.  This may explain why manufacturing survey data is so weak while service survey data has held up well.  

My best guess is that we are going to continue to see confusion until policy makers are more aligned.  In fact, that is why there are so many calls for the Fed to start cutting rates soon, so they can catch up and unify monetary policies around the world.

Ok, let’s see how things looked overnight.  After yesterday’s reversal and lower closes in the US, that theme was extended largely around the world.  Japanese shares fell (-0.75%) as did shares everywhere else in Asia (Korea, India, Australia, etc.) except in China, where both mainland and Hong Kong shares were essentially flat.  The story is no better in Europe where shares are lower by between -0.7% (DAX ) and -1.1% (CAC, FTSE 100) as investors demonstrate they are concerned with the future.  As to the US, at this hour (7:15) futures are very slightly lower.

In the bond market, after yesterday’s poor auction, and ahead of today’s 30-year Treasury auction, yields have fallen from their highest points.  Treasury yields (-3bps) are pacing the European sovereign market (Bunds -3bps, OATs -3bps, Gilts -1bp, BTPs -2bps) as the fear factor on stocks seems to be encouraging some haven buying.  But the most interesting thing was that JGB yields fell -5bps overnight and are now back down to 0.84%.  The BOJ Summary of Opinions (effectively their Minutes) was released last night and clarified that they are not interested in a rapid tightening of policy.  Given GDP growth was negative last quarter, this can be no surprise.

In the commodity markets, oil is little changed this morning but has recouped most of its losses from the past week and sits back at $75/bbl.  This is still a range-bound situation, and we need something really big to change that.  Gold (+1.1%) is making a comeback and back over $2400/oz as the fear factor seems to be playing a role here today.  However, copper (-0.2%) continues to demonstrate short-term concerns over economic activity around the world.

Finally, the dollar is having a much less volatile session than we have seen recently.  AUD (+0.5%) is the biggest mover I can find after hawkish comments from the RBA, claiming they will not hesitate to raise interest rates again if inflation reappears.  However, the yen (+0.15%) seems like it has found at least a temporary home, perhaps gaining some support on what appears to be a risk off day.  Funnily, though, the major risk proxies in the EMG space, ZAR and MXN are virtually unchanged this morning.  I believe that like most markets today, more clues are sought before views are expressed.

Speaking of clues, this morning brings the other US data with Initial (exp 240K) and Continuing (1870K) Claims at 8:30.  Richmond Fed president Barkin speaks at 3:00 this afternoon, the same time we will hear from Banxico on their rate decision (no change expected).  But once again, there is not much new information expected, so markets are going to respond, in my view, to equity activity.  If US stocks can find support, look for other markets to follow along.  However, that does not feel like today’s message.  As to the dollar, against the majors, I think it has found a temporary range.

Good luck

Adf