Tag Archives: #riskoff

Doom Was Misspent

Posted on by 
The 10-year yield hit Five Percent
And somehow, despite this event
The nation’s still here
And growth’s still in gear
Perhaps all that doom was misspent

It’s not to say things are all great
And many, til Wednesday will wait
To see if the Fed
And chief talking head, 
Chair Warsh, will then bless a new rate

I’m going to let pictures do much of the talking to start this morning as we are seeing significant moves across the board in various classes.  To start with government bonds, here is this morning’s view from a Bloomberg screenshot.

As you can see, yields have jumped with most nations seeing them climb around 5bps or more.  (Canada, Brazil and Mexico are not yet open, hence the lack of movement). Prior to touching, and now breaking the 5.0% level, the punditry had spilled a great deal of ink regarding how devastating this was going to be for both risk assets and for the US economy.  On the first count, if we look at equity markets around the world this morning, they were correct, selling is the name of the game as you can see in the below screenshot from tradingeconomics.com

There are not many happy equity investors this morning, although energy shares are holding their own better than most other things.  (Again, Canada and Mexico are closed.)  But as to the second point, it remains to be seen how devastating 5.0% yields on the 10-year Treasury are going to be.  And of course, we still have the FOMC meeting starting today with the policy announcement and press conference coming out tomorrow afternoon. 

But here’s the thing to remember about the equity markets, even the NASDAQ, which has had the most discussion as the tech sector has been rerating lower, is only lower by 6.3% from its all-time high seen in early June.  While nobody ever likes to see their portfolios decline in value, prices remain dramatically higher over the past several years and all three major indices are still higher by 10% or more so far in 2026.  It is hard to call the below chart of the NASDAQ bearish!

Source: tradingeconomics.com

Which, I guess, takes us to the Fed and the ongoing discussion about what they will do.  Depending on where you look, the probability priced into markets for the Fed to hike rates tomorrow is 92% (CME futures) or 100% (rateprobability.com).  Looking at the latter’s most recent chart of the six major G10 central banks, market expectations are for interest rates to rise over the next year by at least 100bps across the board.  (Australia just hiked rates last week so that was their first 25bps).

Now, I often make the case that market pricing ought to be the key feature to watch when considering a situation, but I have to admit, when it comes to the Fed funds rate, there is a bit more to the story, namely the politics involved.  

Let me start by repeating my view that I believe a rate hike would be a mistake.  While headline inflation is running above target, it remains largely an energy story, and we all understand that is outside the Fed’s control.  But if you dig deeper into the inflation statistics, things are not great, but not calamitous either.  It is ironic, if Congress were truly worried about inflation, they would cut spending to balance the budget at which point I am highly confident inflation would no longer be a concern.  Martin Armstrong (@StrongEconomics) made an excellent point this morning on X worth repeating here relative to the FOMC meeting.

As to Chairman Warsh, I think he still must be frustrated that the discussion revolves around what the FOMC is going to do but I presume he will take the information of higher yields in the back end into account regarding this decision.  Remember, too, it is not just his decision, 7 voters need to vote for a hike, and while we know there are three that believe it is proper, are there four more?  I guess we will find out tomorrow afternoon.

It’s interesting, even though oil and energy prices remain the key driver of market activity, they get remarkably little press compared to the stock and bond markets.  Sure, there are still stories about how the real energy crisis is about to come, and market pricing is certainly indicating more concern now than several months ago, but the price of Nvidia or Meta or the 10-year is the top story these days.  At any rate, oil (+1.25%) is higher this morning but has stalled just above $100/bbl for now.  Interestingly, NatGas (-0.6%) is softer and the same is true across Europe and the UK.  I find that quite interesting, especially in the latter places, as there is no indication that more supply is forthcoming.  And, not surprisingly, gold (-0.4%) and silver (-0.1%) are slightly softer with the ongoing rally in oil prices.

Finally, the dollar, which had a very strong session yesterday, is continuing to rally this morning.  it seems that even though interest rates are rising around the world, those higher rates only help the dollar.  Perhaps this is one reason that despite all the hate the dollar absorbs from a certain part of the financial community, it remains the haven of choice.  Open capital markets are worth an awful lot to international investors, and none are more open than those in the US.

Perhaps this is a good time to discuss China, a land of closed capital markets,  and what is happening there.  Last night they released some of their key economic statistics and, the idea that domestic demand is being supported is a joke.  

Source: tradingeconomics.com

It is very difficult to look at these numbers and think things are going gangbusters there.  For instance, the housing market, which has been a key destination for private savings has been declining for five years and has been negative for more than four.

Source: tradingeconomics.com

But more tellingly to me was the new regulations that were imposed starting today regarding the ability of people in China to simply leave the country on holiday.  The below tweet from journalist Melissa Chen from The Spectator is a telling sign that there is growing stress in that nation.

Again, my point is that as many problems as exist in the US, and we have plenty, it is not as though other nations are killing it.  Rather, they, too, are being killed.  Now, has this impacted the CNY?  Not at all.  It is a completely controlled currency and the PBOC is slowly driving it higher although it remains massively undervalued.  As to the rest of the FX market, the dollar is stronger by somewhere between 0.1% and 0.3% nearly across the board with only KRW (-0.9%) outside that window, but remember, the won has been flying over the past two months, so a little pullback is no surprise.

On the data front, this morning brings Empire State Manufacturing (exp 14.75) and that’s it.  It is also worth mentioning that the German ZEW Sentiment Index was released at a weaker than expected 34.7, just showing that there is a bit of despair all around the world.

I have a feeling today is going to be relatively quiet as all eyes look to the Marriner Eccles Building and Chairman Warsh tomorrow afternoon.

Good luck

Adf

Tossed to the Fates

Posted on by 
The market’s now certain this week
On Wednesday, when Warsh gets to speak
That he’ll have raised rates
And tossed to the fates
Just how much more havoc he’ll wreak

But ask yourself, what would you do
As Fed chair, midst this ballyhoo
A rate hike don’t drill
Instead, it might kill
The growth impulse we’re living through

I guess it’s a done deal, at least in the market’s collective mind, that the FOMC is going to hike rates on Wednesday.  This is according to the Fed funds futures market as you can see below.  In addition, you can see that the futures market is now pricing essentially 4 hikes over the course of the next year.

So, why the change of heart?  Apparently, the ‘hot’ CPI data from Friday combined with higher oil prices this morning has sealed the deal.  Let’s take the two in order.  Below are the reported CPI figures from Friday:

Source: tradingeconomics.com

It seems the fact that the M/M Core result was 0.3% instead of the 0.2% forecast, despite the fact that the Y/Y number was as expected at 2.4%, has been the catalyst for the increased certainty of a hike.  You may recall that Friday before the CPI release the futures market had priced in about a 60% probability of a hike, i.e., still a lot of uncertainty.  Of course, oil prices (+2.6%) are higher this morning as well after the Saudis cut movement through their East-West pipeline once it had been attacked, which has further reduced the flow of oil from the Middle East.  And certainly, if oil prices continue to rise, that will feed into inflation pretty quickly as we saw at the beginning of the summer.  

However, just for a moment, let us consider the rationale behind raising interest rates to address inflation.  The main central bank thesis is that higher interest rates will reduce demand and therefore it will reduce price pressures.  This process takes some time, the so-called long and variable lags of Fedspeak, but this is what it boils down to, reduce demand to reduce prices.  As an aside, history has shown that every economic boom has been ended by the central bank squashing it with higher interest rates.

But now let us consider the current situation.  Higher oil prices are certainly driving up some portion of the overall consumption basket, and that is responsible for the bulk of the rise in measured inflation.  Higher oil prices are also acting as a dampener of demand as money that may have gone toward other things is now being used to pay up for gasoline and diesel.  The natural result is those other things, whether goods or services, have seen demand slip somewhat and the purveyors of those things have limited ability to raise prices, at least those not getting paid directly by governments like healthcare providers.  In other words, higher oil prices are already reducing the demand that the Fed will be trying to address via a rate hike.

If the Fed decides to hike rates this week, they will be reducing demand further and could well push the economy off its current solid growth path to something less positive where companies see further reductions in demand and begin to reduce headcount.  Again, history has shown that central bank rate hikes to address energy price shocks (or really any exogenous price shocks) have been categorical mistakes.  I fear this is where we could be headed.  And the worst part is that if they hike rates, it won’t change oil prices at all. 

As a reminder, a quick look at the Atlanta Fed’s GDPNow Q3 GDP estimate shows things are looking pretty good at 4.4%.

Perhaps this discussion is the reason that I am most positive about Kevin Warsh as chairman.  I don’t know if they will hike or not this week, but the entire idea of the five task forces is to try to change the way the Fed looks at the world.  Their neo-Keynesian view has become destructive, in my mind, given the complexities that have arisen in the economy with globalization dramatically reduced and trade policies no longer moving toward free trade.  As well, the changing demographics of the US, both via an aging population and a reduction in immigration in addition to actual deportations is having a significant impact on the economy and does not appear to have been taken into account in the current Fed models.

Away from this discussion, the other main topic is AI and whether it will, indeed, kill us all, or whether it is simply a very powerful tool that if used well can enhance productivity.  Like most issues these days there doesn’t appear to be any middle ground here.  For me, I have a hard time overcoming the perspective that there is a well-orchestrated campaign now to demonize AI in an effort to get the government, at both state and federal levels, to regulate it more strictly, although I don’t know who benefits from this most so I’m not sure who is funding it.  It’s almost as though the demonization of data centers has been unable to slow the train enough, so they had to up the ante and explain AI is Skynet.

Ok, let’s see how all this new news is impacting markets.  Since commodities seem to be the primary driver right now, if we look beyond oil, we see NatGas (+2.3%) rising this morning but it remains extremely well behaved and substantially cheaper than in Europe and the UK as per the below chart from tradingeconomics.com

In fact, putting all three prices into $/MMBtu, the US is at $2.89, the UK is at ~$27.75 and the EU is at ~$27.99.  In other words, Europe and the UK are paying nearly 10X what we pay for NatGas.  They have serious problems there.  As to the precious metals, they are not that precious this morning as the negative correlation with oil continues (Au -1.3%, Ag -2.1%, Cu -1.9%).

Turning to bonds, this is the other key discussion point as 10-year yields approach 5.0% in the US.  This morning, Treasury yields are unchanged, although they have climbed 31bps in the past month.  European sovereign yields are all a touch higher with Italy (+4bps) in the worst shape but the rest of the continent seeing yields climb between 1bp and 3bps.  And JGBs, ahead of the BOJ meeting on Friday, have edged higher by 1bp.

In the equity markets, Friday’s US rally (which given all the hype on the Fed tightening seems strange, although oil prices did slide then, has been followed by a mixed picture in both Asia and Europe.  In Asia, the Nikkei (-0.8%) suffered although the broader TOPIX (+0.75%) did not.  HK (+0.5%) rallied as did some of the smaller regional markets (Australia, Singapore, Malaysia) but there was more substantial weakness amongst Korea (-3.25%) and China (-0.7%). Mixed describes it well.  in Europe, there is far more red (Italy -1.1%, Spain -0.85, France -0.7%, Germany -0.3%) than green (UK +0.7%) with the latter benefitting as oil stocks (BP and Shell) both rallied on the back of oil price rises and that has been sufficient to counter the other negativity.  As to US futures, they are all lower this morning with the NASDAQ (-1.5%), leading the way with the others lower by -0.5% or so.

Finally, the dollar is rocking this morning, with DXY (+0.4%) a pretty good indicator of things.  EUR, AUD, NZD, JPY are all lower by about that amount, as is NOK (-0.4%) despite the rise in oil prices.  SEK (-0.8%) is the G10 laggard but it has company with ZAR (-0.8%) on weaker gold prices and CE3 (PLN -0.9%, CZK -0.75%, HUF -0.8%) all demonstrating their high beta to the euro.  In LATAM, MXN (-0.6%) and CLP (-0.6%) are both under pressure on metals weakness and even KRW (-0.3%), which has been on a tear, is softer this morning.  Higher US rates and the prospect for even higher ones seems to be driving market activity.

On the data front, obviously, this week is all about the Fed, but here is the other stuff:

TuesdayEmpire State Manufacturing14.75
WednesdayRetail Sales0.9%
 -ex Autos0.6%
 FOMC Decision4.0% (current 3.75%)
 Brazil Interest Rate Decision13.75% (current 14.0%)
ThursdayInitial Claims205K
 Continuing Claims1775K
 Housing Starts1.31M
 Building Permits1.41M
 Philly Fed32.5
FridayBOJ Interest Rate Decision1.25% (current 1.00%)
 IP0.3%
 Capacity Utilization76.4%
 Leading Indicators0.1%

Source: tradingeconomics.com

So, it all comes down to, will they hike or not.  While I don’t believe it is the right thing to do, the market certainly believes that to be the case.  I wouldn’t be surprised, however, if they do hike, to see a counter reaction, like a buy the rumor, sell the news outcome, especially in the FX markets.

Good luck

Adf

Center of Blame

Posted on by 
It's not just the 'economy's heat
Why we're at the edge of our seat
But also, Iran
Where this all began
That's left traders feeling downbeat

Thus, crude oil's back in the game
As being the center of blame
How high can crude rise
Til bonds paralyze 
Activity, snuffing that flame

Bond yields remain topic A this morning as they continue to climb around the world.  There are many opinions as to why that is happening but I think it boils down to either 1) increasing deficit spending by governments around the world resulting in significant increases in supply thus driving yields higher, or 2) rising oil prices after the US-Iran conflict has seen an increase in military action on both sides thus driving the inflation narrative further.  Arguably, it is a combination of both these things.

Much has been written that these are the highest yields since 2011 or 2008 (or 1996 in Japan’s case) and how that makes them, somehow, more dangerous.  Or at least that is the implication.  When it comes to bond yields though, I always like to maintain perspective by looking at the long-term history of 10-year yields.  If you look at the chart below from FRED, I think it fair to ask the question, what is the aberration, current yields at 4.8% or yields at 2.5% or lower seen post the GFC?

As I have written before, the average 10-year yield over the past 60 years is 5.81%, still 100bps higher than current levels.  I understand that debt outstanding has grown dramatically over the years, but it’s not like it wasn’t growing during Covid.  In fact, it was exploding higher then too.  Ultimately, the original sin is excess government spending relative to the economy’s overall size and, unfortunately, the underlying thesis of RIH is that is not going to change.  To me the question becomes, how does one prepare for the impacts of this policy.  And remember, this is not a US only policy, it is now the default policy of every government in the world, save perhaps Switzerland.

How can it get fixed?  That is the $64 trillion question and there is no easy answer.  If governments around the world reduced their spending, especially on things that add no true economic value (subsidies for green energy are huge and immediately come to mind), it would help but not solve the problem.  Entitlement spending is the major expense everywhere in the G10 and as those nations age demographically, that will only get worse. 

I haven’t discussed the 4th Turning in a while, but this is all of a piece with that scenario, massive institutional changes as old institutions, be they corporations, central banks, government structures or educational organizations, will be redesigned for the new age.  Perhaps that is the promise of AI, a “voice” that can analyze history and help guide future decisions.  Alas, mankind is mankind, and I don’t foresee that changing so whatever comes out on the other side, it, too, will only have four generations of life!

Was it hint or threat?
Could Ueda hike fifty?
No breath holding, please

The other story of note this morning was that BOJ Board Member Takata, a known hawk, gave a speech and indicated that the BOJ could surprise with a 50bp hike this month, or perhaps hike two months in a row rather than their current once every six months cadence.  Bloomberg’s article was succinct.  This story did have a modest impact on the yen (+0.25%) as you can see in the chart below.

Source: tradingeconomics.com

But if we step back from the 1-week view above to the movement over the past year, as per the below chart, it doesn’t appear to have had a significant impact.

Source: tradingeconomics.com

The post-intervention pattern remains perfectly intact.  However, it did help increase the probability of further rate hikes by the BOJ as you can see in the rateprobability.com chart below.  The blue line is the current market compared to previous readings, with the market now expecting a total of 100bps of hikes during the next year. 

Alas, that did not help the JGB market, where yields remain at the 3.0% level, although they did not rise further last night.  Speaking of bonds, Treasury yields, which climbed 3bps yesterday, are unchanged this morning but European sovereign yields are all higher by between 3bps and 5bps, with France the worst case.

Looking at equity markets, red is the color of the day as every major market either declined last night or is in the process of doing so as I type as per the below Bloomberg screenshot.

Certainly, there is a great deal of angst in equity markets right now, but when I looked at the S&P 500, it is still just 2.5% off its all-time highs from the middle of August.  And this morning, while the NASDAQ futures are lower by -0.7%, the other two indices are unchanged as we await this morning’s ADP data (exp 47K) and this afternoon’s Beige Book.  Higher yields are always a struggle for equity markets, but there is no collapse yet, that’s for sure.

In the commodity markets, oil (-0.7%) has backed off the highs from yesterday and has traded back below $90/bbl, although that remains far higher than just a few weeks ago.  The escalation of fighting has certainly got traders nervous.  As to the metals markets, while they have been getting crushed the last few days, this morning they are essentially unchanged, perhaps consolidating after that rough ride.  You may remember there had been a strong negative correlation between oil and gold for a while which seemed to dissipate during the summer when things in the Gulf settled down.  Well, as you can see in the chart below, that negative correlation is back in spades for the past two weeks.  We will have to see how long that lasts, as historically, the two traded together more often than not.

Source: tradingeconomics.com

Finally, the dollar is creeping higher again this morning with the DXY (+0.1%) a pretty good proxy of the entire market with just a few exceptions.  We already noted the yen but NZD (-1.2%) fell sharply after the RBNZ raised rates by 25bps, as expected, but sounded more dovish in their comments afterwards.  As it happens, that helped the NZ stock market buck the negative trend as well.  The other outlier was KRW (+0.8%) which continues to rally strongly on positive inflows and positive economic news.  Last night, inflation data was better than expected, which helped the currency, rather than set it up for a rate hike.

And that’s really it today.  We also get Factory Orders (0.6%, 0.2% ex Transport) and the EIA oil inventories.  ADP could be interesting, but all eyes remain on Friday’s NFP on the data front.  And of course, who knows what will happen in the Gulf.

There will be no poetry tomorrow as we show GCH Nubia’s Take Your Breath Away on the road to the Nationals next month.

Good luck

Adf

A Bad Taste

Posted on by 
For weeks, things appeared to get better
As yields slipped and helped every debtor
But we’ve seen some changes
With yields breaking ranges
And oil back to the pacesetter

So, stocks are not really embraced
While bonds have left all a bad taste
The dollar’s moved higher
While gold’s back to dire
With analysts worldwide disgraced

Investors are not as happy this morning as they had been for the past several weeks as the situation in Iran and the Middle East appears to be deteriorating again.  The US continues to attack Iranian missile launchers and fortifications on a daily basis while Iran continues to fire missiles at targets throughout the Gulf region.  As well, the Houthis are back at it in the Red Sea restricting oil flows through there as well.  Arguably the chart below of oil (+4.0%) is the most descriptive view of what is driving everything.

Source: tradingeconomics.com

Crude is higher by 29% in the past month and back above $90/bbl.  This makes things tough on everybody but the oil companies.  Does this mean we are running out of oil?  I don’t think that is the case.  Rather, the short-term impediments to shipping it are driving the price.  But the price is rising nonetheless and that is impacting everything else.  If you recall when things kicked off in this war back in March, the oil price was the primary catalyst for movement in every market. As things seemed to settle down and it appeared there was an opportunity for a resolution, focus turned back to things like earnings for equities and interest rate differentials for currencies with oil in the background.  But it appears we are back to, as oil goes, so goes every other market.

For instance, here is a chart of oil and 10-year Treasury yields over the past month.  As you can see, the trajectory, especially over the past several sessions, is quite similar.

Source: tradingeconomics.com

But if we look at 10-year yields across Europe, we can see that they are all climbing in sync as well.

German yields have reached their highest level in 15 years according to Bloomberg.

The entire moderation story is falling apart.  So, now instead of conversations discussing the relative merits of AI and whether it will be a boon for mankind or end it, we are discussing the probability that the world will end soon.  I guess it’s no surprise that risk is under pressure.  Of course, the latter conversation doesn’t seem that coherent to me as if there is concern over the end of the world, I would have thought gold would have a better bid!

At any rate, oil is the main story and the driver of every market.  It underpins the question of whether the ECB will hike rates today (they won’t) or whether the FOMC will do so next week (also, they won’t) but the probabilities for those moves have risen.  It has also detracted from the earnings stories, or perhaps exacerbated the negatives, or perceived negatives.

For instance, Alphabet reported last night and Q2 revenues beat estimates coming in at $119.8 billion.  But all the talk is of free cash flow, which in this Bloomberg chart shows how much they are spending on the AI buildout.

Here’s my question, is it bad that Alphabet is spending its money to improve its future?  If it recognizes the criticality of AI to the future of its own existence, it seems like a reasonable move.  Of course, the naysayers claim that spending all that cash is a waste.  I don’t know the answer, and I suspect nobody does yet, but companies spending their cash flow on improving their business seems to be the whole idea behind having companies in the first place.  

It begs the question, on what did investors base the value of Alphabet before AI?  If it was seen as only a cash cow, it certainly traded at a very high multiple for a boring business.  But today, it will be tarred with the oil brush along with all stocks.

Ok, I have gone far afield here, let’s get back to markets overnight.  Yesterday’s lackluster US session was followed by strength throughout most of Asia.  Tokyo (+0.5%), China (+0.25%), HK (+1.3%) and Korea (+4.4%) all had solid sessions with Korea continuing to define what volatility means in equity markets.  Look at the expansion in the daily ranges in this barchart.com chart of the KOSPI over the past month.  It’s remarkable!

European bourses, though, are having a much rougher go of things this morning as Brent crude approaches $100/bbl.  France (-1.1%), Italy (-1.9%), Spain (-0.6%) and Germany (-0.6%) are under real pressure this morning as earnings numbers there have been lackluster and the broader macro picture deteriorates all the while.  As to US futures, right now (7:40), they are pointing lower led by the NASDAQ (-1.2%) although it has not yet breached that critical support level as per the below chart.

Source: tradingeconomics.com

We’ve already discussed bond markets, with yields higher this morning by between 2bps and 3bps across Treasuries and all European sovereign markets.  Turning to the metals, while we had a couple of days where they rallied alongside oil, this morning they have reversed course with gold (-1.3%), silver (-2.6%) and copper (-0.7%) all under pressure.  It seems the interest rate story is today’s discussion as higher yields are the topic du jour.

Finally, the dollar is stronger across the board this morning, although most of this strength just materialized over the past few hours with the Asia session broadly unchanged.  But no matter how you slice it, the dollar is firmer vs. all its G10 counterparts by about 0.25% and almost all of its EMG counterparts by a similar amount.  The exceptions this morning are BRL (+0.25%) and KRW (+0.3%).  Regarding Brazil, you must remember they are an oil exporter, so benefit from high oil prices and have amongst the highest real interest rates around, so draw capital for that as well in the carry trade.  The real has appreciated about 8.5% during the past year, so this is nothing new.  As to KRW, the government’s efforts at internationalization continue to be paying off and a look at the chart below shows that this trend is quite strong right now.

Source: tradingeconomics.com

There was an interesting article in Bloomberg this morning explaining how the dollar’s weakness vs. LATAM currencies has begun to bite for local companies but I find it quite interesting when it comes to discussions about the dollar; some find it too strong and are looking for it to tumble while others complain it is too weak!  Seems nobody is ever happy here!

On the data front we see Chicago Fed National Activity (exp 0.14) as well as Initial (212K) and Continuing (1809K) Claims.  Of course, we have the ECB announcement shortly, although no change is expected.  Something getting very little press is the fact that Crude Oil stocks rose in the US last week, but I guess that doesn’t suit the narrative!

This market is entirely focused on oil, and as it moves, so will everything else.  If oil keeps climbing, look for stocks and gold to fall while yields and the dollar rise.  If oil reverses, so with those moves.

Good luck

Adf

Risk-Taking Cracks

Posted on by 
The president told us elections
Were filled with some lethal infections
He’s unclassified
More docs to help guide
The courts to start making corrections

Meanwhile in Iran more attacks
Has led to some risk-taking cracks
Thus, oil is higher
While semis look dire
Have we seen the market climax?

A few words on the president’s speech last night as it was widely touted.  In it, he explained he declassified a trove of documents offering proof that there have been many election irregularities over the past six years, naming China as a major player in the process.  These documents are available online for all to see and ostensibly refute (I have not read them, nor am I likely to do so) that our elections have been secure in the US.  In fact, the same government analysts that have declared there to have been no issues are the ones who these documents purport to show were interfering.  My only observation, especially on this topic, is that no matter the proof available, minds have long been made up, and this will not change opinions, at least until arrests are made and trials are held.

Which takes us to more relevant market issues.  Arguably, the poster child for semiconductor stocks is the Korean KOSPI (-6.4%), where just two companies, both major players, Samsung and SK Hynix, represent some 40% of the index value.  As you can see from the below chart, it has been tough sledding for the past month, with that market closing lower by nearly 28% from its highs on June 22nd.

Source: barchart.com

And while that may be extreme, if we look across major markets in Asia, there was some rough times last night almost everywhere.  Tokyo (-4.0%), HK (-1.8%), China (-3.6%) and Taiwan (-6.5%) all had serious dislocations downward.  And, of course, the thread running through them all is the tech exposure.  There has been much discussion of a rotation out of tech and AI stocks into other areas, with financials and energy amongst the beneficiaries, and certainly, last night’s price action supports that thesis.  Interestingly, India (+1.25%) completely bucked that trend, but then, India is perceived to be a major loser from the AI story, so if that is unwinding, I guess it’s no surprise that India benefits.  Elsewhere in the region, things were far less volatile.

As to Europe, despite a glaring dearth of technology companies, equity markets there are also under pressure this morning (DAX -0.9%, CAC -0.9%, IBEX -0.5%, FTSE 100 -0.1%) although that is more likely to be a response to the fact that oil prices have picked back up as the US resumes more aggressive military activities against Iran.  As to US futures, at this hour (6:45), they are all lower led by the NASDAQ (-1.8%) although both the SPX and DJIA are down by -0.7%.

Which takes us to oil.  The black, sticky stuff is higher by 2.0% this morning, although, as you can see from the chart below, it is still hovering right around $80/bbl, the level I described as its new home earlier in the week.  

Source: tradingeconomics.com

The key question here remains just how much of an interruption in economic activity has been caused by the Iran conflict.  Not dissimilar to the election question at the top, it seems the two sides of this argument are dug in and will countenance no discussion that they are misreading the situation.  There are still analysts who discuss tank bottoms and the idea that now that so many reserve inventories have been released, we are quickly approaching a situation where their much mooted $200/bbl is right around the corner.  And yet, despite the tick higher overnight, the market continues to price a relative lack of concern over future supplies.  As always, I go with prices as the best arbiter, but that’s just me.  The massive production increases from the US and Canada, as well as Brazil and Guyana, increases from Venezuela and the workarounds by the Gulf nations to get their oil to market continue to demonstrate that supply is available.  

One wild card that is very difficult to completely understand is China, where things are always opaque, and where their imports have fallen sharply, thus reducing demand.  Was that demand “destroyed” in the sense that it will never return?  Seems unlikely.  Rather, my best guess, and it is just a guess, is that China tapped into their own SPR and has been using that, rather than importing.  Whatever the situation, there appears to be no shortage of oil available.  

One other thing weighing on the price has been Ukraine’s success in attacking Russian refining capacity.  If the Russians cannot refine their oil, they need to sell it as crude rather than products, and that is adding to the inventories available for sale.  It is also part of the explanation as to why products prices and the crack spread remain so high, more oil, less refining.

Looking at precious metals, gold (+0.4%) closed below $4000/oz yesterday for the first time since last November as per the below chart.

Source: tradingeconomics.com

Silver (-0.4%) also remains under pressure and this morning copper (-1.9%) is suffering alongside the precious space.  But perhaps a few words on what gold really represents are in order.

As J.P. Morgan said in 1912, before the Federal Reserve was created, “Gold is money, everything else is credit.” Certainly, the second part of the statement is correct as your bank deposits rely on your bank standing behind them, making you a creditor of your bank.  Federal Reserve Notes are paper obligations of the US government, so again, represent purchasing power, but as we have learned, a decreasing amount of it every day.  Meanwhile, gold has a 5000-year history of being accepted as a thing of inherent value.  Now, the widely accepted definition of money these days is it must have three characteristics; it serves as a medium of exchange, a store of value and a unit of account.  Gold historically has served as the first two, although rarely as a unit of account.  Rather, gold holdings were always converted into whatever the unit of account was at the time.

Which takes us to the present, why does gold continue to represent a part of the financial markets, and over the past several years, an increasingly important part.  I would contend this is all of a piece with the broader changes in the global community, notably the end of the Pax Americana, where the US no longer chooses to (or can) guarantee the peace of the post WWII and Cold War worlds.  Instead, we have seen a constant increase in debt by every nation as governments around the world seek to placate their own citizens and are unable to pay for all the goodies they offer, thus borrow the difference.  

However, the freezing of Russian reserve assets by the West in the wake of the invasion of Ukraine has altered many views about what is safe and represents value, and what is paper and doesn’t represent value and central bankers, charged with maintaining a nation’s wealth, have gone back to gold as the one thing they know will retain value given it is nobody’s liability.  The chart below shows activity in May, which is similar to what has been happening virtually every month, that central banks are relatively price insensitive, buying the stuff as a strategic asset.  And the sellers, were selling because they needed the money!

One last chart to make the point about gold and purchasing power.  The below chart from the FRED database demonstrates just how much purchasing power the dollar has lost since the Fed came into existence; i.e. just how much inflation has destroyed the real value of the dollar.  For reference, that opening level is 1021 compared to today’s 29.9, a 97.1% devaluation in 113 years of the Fed.  It can be argued that the Fed has failed catastrophically in their effort to maintain the value of the dollar.

Ok, quickly elsewhere bond yields have edged lower, with Treasuries (-3bps) leading the way and European sovereigns either unchanged or having slipped by -1bp.  JGBs overnight also slid -2bps, but overall, while there is a lot of discussion about yields, they are not moving very far.

Finally, the dollar is a bit firmer this morning with the pound (-0.3%), Aussie (-0.4%) and euro (-0.1%) all slipping although NOK (+0.2%) is benefitting from oil’s move.  In the EMG bloc, though, there is more trouble with KRW (-0.5%), ZAR (-0.6%) and MXN (-0.3%) representative of more anxiety there.  Ultimately, I still have a hard time getting too bearish the dollar in the current world.

On the data front this morning brings Housing Starts (exp 1.31M) and Building Permits (1.40M) as well as IP (0.2%) and Capacity utilization (76.2%).  Finally, at 10:00 we see Michigan Sentiment (51.0).  There are no Fed speakers scheduled, and they are entering their quiet period, so we won’t hear from them until the meeting on the 29th.  (Perhaps we won’t hear from them anymore after that too!). 

Summing up, Iran and oil are still key drivers, equity market rotation is happening, although given how far it has moved, we may be near the end of that process, and yields have no direction.  Regarding yields, we may have reached the point where the issue is not inflation concerns, per se, but rather the sheer volume of debt that is going to be issued going forward, and the fact that private investors want more yield to be persuaded to buy it.  As to the dollar?  Like I said, I just don’t see the bear case over any longer-term horizon.

Good luck and good weekend

Adf

The Score

Posted on by 
Hormuz is blockaded once more
The latest response in the war
So, crude prices rose
While both sides expose
Their relative views of the score

Now after a month of some peace
Seems tensions are set to increase
So, what about stocks?
The sales are in blocks
While buyers, few bids will release

After a brief respite for markets, where oil had seemed to be drifting out of the headlines, the events of the past weekend plus the US reimposition of the blockade of the Strait of Hormuz has changed the narrative dramatically, and rightly so.  The benign attitude of an eventual conclusion to this situation has been tossed aside and the oil bulls and war hawks are both back in the ascendancy.  Yesterday ultimately saw oil prices rise 9.4% and this morning they are a further 3.2% higher, and perhaps more importantly, back above the psychological level of $80/bbl.

Source: tradingeconomics.com

There doesn’t seem to be any short-term solution to this situation.  There are clearly enough hard-liners still with power in Iran to prevent any move toward a negotiated solution.  As long as this maintains, the outlook for oil will tilt higher.  However, as I have written before, and is very clear now, the effort to reroute oil shipments from the Gulf nations away from the Strait is intensifying and will continue to do so.  As well, alternative sources of supply including additional US production, Brazil, Argentina, Guyana, Venezuela and Canada are satisfying demand.  While uncertainty remains high, especially in the short run, by the end of next year, my take is less than 8% – 10% of the world’s oil will need to transit the Strait.  However, in the meantime, given that everybody who was long oil as the war initially ramped up has sold out, there are few sellers left to cap the price.  I imagine a move toward $90/bbl is quite possible in the next weeks.

As well as the story on crude
Two other themes will be pursued
First CPI’s print
Will offer a hint
Then Warsh will discuss why he’s screwed

If we turn our attention away from the oil market now, the two main events today are the CPI release at 8:30 this morning followed by Chairman Warsh testifying to the House Financial Services committee in his semi-annual trip to Congress.  Starting with CPI, expectations are for a decline from last month as headline (exp -0.1% M/M, 3.8% Y/Y) and core (0.2% M/M, 2.8% Y/Y) are due.  From what I can tell, there are a number of analysts who are calling for a relatively hotter number, although I’m not sure on what basis they believe that.  Certainly, oil prices, and energy prices across the board, declined significantly in June and that will be reflected in the reading.  Looking at the home price data, that doesn’t appear to have risen dramatically, and other commodity prices have also slipped.  I don’t’ rule out any outcome, but on the surface, expectations seem reasonable.  

Of course, with oil prices rising, talk of more rate hikes is all the rage and according to the Fed funds futures market, as per the below CME table, you can see that expectations have risen to a 40% probability of a hike this month and a two-thirds probability of two hikes before the end of the year.  My personal view, FWIW, remains that there will be no hikes this year, although with the resumption of hostilities in the Gulf, I think a cut is off the table as well.  Remember, too, that if oil prices remain elevated that will negatively impact economic activity, so hiking rates into that scenario doesn’t seem to make much sense.  But then, I’m not on the FOMC.

Now, I have long maintained that FOMC members should shut up, but it seems Mr Warsh will have a hard time getting them to do so.  I’m not sure if they think they are helping, or they are just enamored with their own voices.  But yesterday, Governor Waller spoke and explained that if the CPI data was hot, a rate hike would be an appropriate response.  And remember, we hear from another 7 or 8 of these folks just this week, four today!  

While I expect that Warsh’s testimony will be dry, and that most of the questioning will be either long-winded preening by some idiot member, or an attempt at a gotcha question, I am confident that Chairman Warsh will continue to avoid discussing his views of where policy should go and reiterate forcefully that the Fed’s goal is to reduce inflation, full stop.  I am also confident that he will not be dragged into any discussions of other issues like global warming or DEI and simply repeat that ending inflation is the only job he has.  We shall all find out shortly.

On to the markets.  It should be no surprise that equity markets were under pressure yesterday in the US with the jump in oil prices.  This added to the chorus of those who believe the AI bubble is popping as the NASDAQ led the way lower, falling -1.5%.  But a funny thing happened in Asia.  Despite the jump in oil prices and declines in US equity markets, Tokyo (+0.75%), HK (+0.5%) and China (+2.15%) all rallied nicely last night.  In fact, so did Korea (+0.7%) and Malaysia (+1.3%) although we did see declines in India (-0.7%) and Taiwan (-1.4%) with the rest of the region moving far less.  This is a surprising outcome to me, especially as Asia is the region most negatively impacted by rising oil prices.

Europe though is trading true to form with declines across the board ranging from Spain (-1.1%) to the UK (-0.4%) and everywhere in between.  There has been precious little data overnight to drive things, and this appears to be entirely oil related.  Of course, Europe’s suicidal energy policy, notably the UK’s ban on drilling for oil in the North Sea, remains one of the key reasons that the area will continue to struggle.  As to US futures, this morning DJIA futures are lower (-0.8%) but the other two major markets are little changed at this hour (7:25).

In the bond market, 10-year Treasury yields jumped 6bps yesterday although are little changed this morning.  However, as you can see from the chart below, they are pushing back up toward the highs seen in late May.

Source: tradingeconomics.com

There is a lot of talk about how Warsh should hike rates aggressively this month to gain bond market credibility in his fight against inflation, but I sense that is a lot of people talking their books.  I continue to believe that there will be no Fed action ahead of task force reports.  As to other nations, yields are generally firmer in Europe today, ranging between +1bp (Germany) and +3bps (Italy) with the UK worst of all (+4bps) as 10-year Gilts now yield more than 5.0% again, also pushing back to late-May highs.  The one exception is Japan (JGBs -5bps) where the latest ploy by Katayama-san is to propose JGBs be allowed to be invested in tax-free accounts for individuals in Japan.  Given the long history of zero rates there, a tax-free return of 2.7% with no currency risk could well be quite attractive, I think.

In the metals markets, it is no surprise that both gold and silver fell yesterday with the jump in oil prices, but despite oil’s continued rally this morning, both gold (+0.7%) and silver (+0.7%) are finding support, with gold seeming to hold the $4000/oz level for now.  Copper (+1.6%) is also holding up well, but its relation to the precious sector seems to be waning.  Perhaps the precious metals story is less about oil and more about the dollar.

Turning to the dollar, yesterday it put in a strong performance with the DXY rallying about 0.3% from Friday’s closing levels as you can see in the chart below.

Source: tradingeconomics.com

However, as you can also see in the chart, this morning the greenback is under pressure despite the rise in oil prices and yesterday’s increase in yields.  The biggest outlier is NZD (+0.9%) as the RBNZ continues to make hawkish statements about the need for further rate hikes.  And of course, NOK (+0.7%) is benefitting from the oil price rise.  But the rest of the G10 are all firmer, and so is most of the EMG bloc with only INR (-0.5%) standing out as underperforming.  That story appears to be based on higher oil prices and concerns, or thoughts at least, that the RBI will not be aggressively hiking rates to protect the rupee.  Otherwise, most currencies have moved higher vs. the dollar on the order of +0.15% to +0.25%.

And that’s really it today with CPI the only data release other than the already released NFIB Small Business Optimism index (97.4, exp 95.8), but that predates the change in the Gulf.  Chairman Warsh has his work cut out for him to get his colleagues to shut up.  I wonder if he can fine them if they speak.

We are in a narrative transition right now, but longer term, I remain bullish the US and the dollar.  

Good luck

Adf

Theses All Wrecked

Posted on by 
There once was a fire that ceased
Which many hoped would lead to peace
But recent attacks
On ships did climax
In poking the milit’ry beast

The market’s response was direct
With oil bears’ theses all wrecked
The dollar, it rose
While risk takers chose
Their stocks and bonds, now, to reject

While we had all become accustomed to the gradual decline in the price of oil as it appeared there was a solid chance that an agreement would be reached between Iran and the US, that all came a cropper yesterday after Iran attacked 3 different ships exiting the Strait and the US responded with attacks on more than 80 targets, including (according to the WSJ) “air-defense systems, command and control networks, antiship missile sites and more than 60 Iranian small boats near the waterway.”  This was a significant uptick in the nature of the response from previous skirmishes and according to President Trump, the ceasefire is over.

“To me, I think it’s over, I don’t want to deal with them anymore,” Trump told reporters at a NATO summit in Ankara on Wednesday. “They’re liars, they’re cheats, they’re sick people.” 

Given the sudden change in the status in the Gulf, we cannot be surprised by the market response.  WTI (+6.0%) rocketed higher as you can see in the chart below.

Source: tradingeconomics.com

And while that is clearly a significant move, and has changed attitudes in the market, I think it is worth stepping back slightly and looking at the price action over the past month, just to remind ourselves that though things may be changing, we have still seen a dramatic decline in price.

Source: tradingeconomics.com

Here’s the thing, right now there is no way to know if we are going back to the situation in early March, where there was substantial fighting, or at least bombing and missile attacks, each day, or if this, too, is going to pass like the previous minor skirmishes.  Certainly, President Trump appears tired of the current situation, but it is not clear what type of further response is in the offing.

In the meantime, given the new military action and the limited prognosis for a quick return to the previous status of ships moving through the Strait, it can be no surprise that investors decided to dump a lot of risk.  So, let’s take a look at how things behaved overnight.

You will not be surprised that equity markets are broadly lower this morning.  Yesterday’s US session was soft on concerns over the tech sector and that was before the resumption of hostilities in Iran.  So, Tokyo (-2.1%), China (-0.8%), Korea (-5.4%) and India (-2.2%) all fell sharply amongst major markets in Asia with most of the smaller exchanges under pressure as well.  The outliers here were HK (+3.0%) and Taiwan (+0.6%) as both saw continued demand for semiconductor and tech shares.  It feels to me that these two markets will have difficulty maintaining this positivity under the current circumstances.

In Europe, it is a bloodbath with all major bourses lower led by Germany (-2.4%) and Spain (-2.7%) while France (-2.2% and the UK (-1.6%) are not far behind.  The NATO meeting ongoing in Ankara is not helping anybody’s views as President Trump continues to add pressure to NATO to pay their own way.  Ultimately, the NATO transition continues, and it is anybody’s guess as to how involved the US will be going forward.  As to US futures, at this hour (6:35) all the major markets are lower by -1.0% or more.

In the bond market, yesterday saw Treasury yields rise 6bps during the session as yields tracked the oil move pretty closely.

Source: tradingeconomics.com

This morning, Treasury yields are higher by 2bps more but that is nothing compared to the European sovereign markets, which as you can see from the below Bloomberg.com screenshot are substantially higher this morning.

All those visions of inflation finally starting to decline were abruptly altered after the renewed activities in the Gulf.  Adding to the pressure on bonds is the concern over the increased spending promises from governments around the world which has seen traders increase short positions in the bond market to near record levels.

We cannot be surprised that gold (-1.2%), silver (-2.2%) and copper (-2.2%) are lower in response to the renewed fighting and rise in oil prices as that relationship has been very consistent.  We also cannot be surprised that the dollar is a bit firmer this morning, although not universally so.  For instance, JPY (-0.2%) is now pushing back to its recent lows (dollar highs) although the pace of movement remains quite modest.  As well ZAR (-0.6%) is also under pressure amid the decline in gold prices and rising oil prices (they are an importer of oil).  On the flip side, though, NOK (+0.4%) is benefitting from oil’s rally as is CAD (+0.25%) while KRW (+0.6%) seems to be benefitting from money flowing home after the recent equity rout there (covering margin calls?).  NZD (+0.4%) strengthened on the back of the RBNZ raising their base rate by 25bps as they continue to have some concern over inflation, but that only takes it back to 2.50%, hardly tight money.  As to the other main currencies, they have not really done that much, although lean slightly lower this morning.

On the data front, we see the EIA oil inventory data with draws still expected, as well as a 10-year Treasury auction, where it will be quite interesting to see if investors are keen on the extra yield now available.  And we get the FOMC Minutes, which despite the Iran situation, will still be keenly watched and read as the analyst community tries to get a better understanding of the way the Fed will be behaving going forward.  What is the new reaction function?  

Looking at the Fed funds futures market, pricing for that first rate hike has moved to September from the previous October timeframe, and a second hike is back in the cards as well.

However, nothing has changed my view about the way things will evolve.  Certainly, the increased hostilities are a negative for markets, but I suspect that this will be a short-lived episode and things will calm down again sooner rather than later.  With that in mind, I have not changed my view about no rate hikes this year with a potential cut.  However, if this fighting does increase and the oil price creeps higher over the next weeks and months, I will be rethinking this stance.

Right now, we are back to being hostage to events on the other side of the world.  All we can do is watch and respond.  

Good luck

Adf

Stoke Some More Fear

Posted on by 
The word of the day is inflation
As data from many a nation
Appears, still, to show
It has room to grow
With fears this is no aberration

But are things as bad as we hear
From media outlets who cheer
More pain, as they make
Their case Trump will break
The nation, and stoke some more fear

It’s CPI day here in the US and similarly, we got readings from various nations around the world overnight.  To level set, expectations for this morning’s numbers are:

  • Headline – 0.5% M/M, 4.2% Y/Y
  • Core – 0.3% M/M, 2.9% Y/Y

On an annual basis, as you can see in the below chart from tradingeconomics.com, 4.2%, while much higher than some recent data and much higher than we would like, was seen as recently as April 2023 during the “transitory” phase from the Covid years.

And don’t get me wrong, I am as sensitive to inflation as all of you as I go to the supermarket or Costco and see prices and fill up my car’s gas tank as well.  In fact, speaking of gasoline, there is no question it is much higher than it was prior to the beginning of the Iran conflict.  Looking at the chart I drew from FRED data below shows that, nominally, it is back at levels from the immediate aftermath of Russia’s invasion of Ukraine in 2022.  But look at the other line on the chart, that is the price of a gallon of unleaded adjusted for CPI starting back in 1990.  It is remarkable that the latest reading, while still obviously higher than a few months ago, is just $1.635/gallon in real terms.

Somebody else pointed out that gasoline is one of the few things that seems rarely to be described in real terms, arguably because it hasn’t really risen all that much over time and those who describe things in real terms are frequently trying to make the point that inflation is far too high.  Arguably, though, this is further proof of famed economist Julian Simon’s thesis that commodity prices all head lower over time as the ability to produce them in abundance, and their relative abundance in the earth, drive those prices lower.

As to elsewhere in the world, last night China reported that CPI (blue bars) remained at 1.2% but PPI, which may be a better indication of price activity there, rose to 3.9%.  This implies that Chinese corporate profits are under increasing pressure.  It also represents a sea change in China as can be seen in the below chart where PPI (grey bars) was negative for the 3 years prior to April.  

Source: tradingeconomics.com

As with all inflation analysis, the real question is who absorbs the price pressures.  In the US, the recent experience from Covid, when the government helicoptered $5 trillion into the economy so people had money to spend, businesses raised prices and continue to believe they can do so.  Apparently in China, that is not the case.  To finish the discussion, below is a chart of 17 of the G20 nations and their most recent headline CPI readings (I left out Argentina, Turkey and Russia as I couldn’t fit them all on the screenshot).  Interestingly, only 11 of these 17 nations have seen CPI rise in the past month.  I wonder, is inflation the global phenomenon that some make it out to be.

Country Last. Previous Date

Ok enough on that.  Let’s move on to market activity.  For the past several days, the oil story did not seem quite as important as despite a few random missiles being fired, it appeared that the Iran conflict was quieting down.  This allowed the focus to turn to important things like AI and the SpaceX IPO coming tomorrow after the close.  For example, when I sat down this morning around 5:00, oil was around $87.50/bbl and had slipped slightly lower compared to yesterday’s close.  However, in the interim, President Trump tweeted out the following:

But despite these comments, while oil has jumped as per the below chart, it is just barely at $90/bbl, hardly a sign the market believes something dramatic is on its way.

Source: tradingeconomics.com

In the meantime, there continue to be multiple articles that we are heading to the cliff for oil inventories and prices will skyrocket soon.  You know my opinion on those as I take the market’s side things are not as dire as some believe.

But if things heat up in Iran and the Gulf, I expect that we will see a downdraft in equities and bonds while the dollar moves higher.  And that is what we are currently seeing.  Below is a screenshot of equity futures markets as of 7:45 this morning.

source: tradingeconomics.com

Not a lot of happy faces there.  As well, overnight saw weakness throughout most of Asia after yesterday’s modest US declines.

In the bond market, Treasury yields are backing up 3bps and European sovereign yields are also higher this morning, between 3bps and 5bps across the entire continent.  So despite my statements above that inflation may not be as big a deal as some explain, bond investors are at least a bit uncomfortable this morning.

As to the metals markets, that break below the 200-day moving average in gold is seeing real follow through as old long positions and new short momentum plays pile on with the barbarous relic (-2.5%) tumbling as well as silver (-1.9%) and copper (-1.2%).  The key here is that whatever the short-term price action is, I think the one unalloyed truth is that fiat currencies will continue to get printed like there is no tomorrow and precious metals will regain their form.  But it could take a while.  In that vein, there was a Bloomberg article this morning explaining that more government bonds have been sold at this point in the year, ~$504 billion, than the first half of 2020 with Covid.  If my short-term inflation thesis is wrong, this is the reason why.

Finally, the dollar has edged higher this morning but is generally little changed.  The noteworthy thing is that USDJPY is at 160.50, above the supposed line-in-the-sand for the MOF, but as you can see from the below chart, the movement has been extremely gradual, with very little volatility.  Remember, one of the things the MOF focuses on is that volatility, so if the dollar continues to creep higher, they are likely to hold off for a while before feeling the need to intervene.

Source: tradingeconomics.com

But otherwise, most currency movement has been modest overnight.

Aside from CPI, and the oil inventory data, we do hear from the Bank of Canada, which is likely to leave policy rates on hold.

It feels like the market is getting increasingly concerned over an uptick in activities in the Gulf, which will have a negative impact on financial assets but support the dollar.  We shall see.

Good luck

Adf

Changing the Fate

Posted on by 
With things in the Gulf getting hotter
And risk assets heading to slaughter
The question on lips
Can stocks e’er eclipse
Their highs, or ‘stead sink ‘neath the water
 
But really, the question I’d ask
Is Chairman Warsh up to the task
Of changing the fate
Of the Fed funds rate
And if so, what will he unmask?

It is very difficult to focus on the Gulf situation as not only is it fluid, but there is also no direction of travel whatsoever.  So, this morning I want to have a different conversation.  Let me start by explaining this isn’t my idea, per se, although the analysis is solely mine.  Listening to the Macro Voices podcast Sunday morning while walking the dog, (he’s the one on the left)

Michael Every was on and expressed a very interesting thought, one that I had not considered, nor heard anywhere else.  What if the Fed, as Chairman Warsh seeks to adjust how it works, decides that they are going to put their fingers on the scale with respect to the interest rates paid by different industries, not merely by differently rated credits.  The idea is that in conjunction with the Treasury, Warsh and Bessent would decide which industries needed to have the most cost-effective funding for the nation to be able to maintain and develop the industries necessary for national defense reasons.

Now, I know this is anathema to almost all of us having been raised on the idea(l) of free markets and that markets are better at allocating, well everything, but in this case credit, than any cabal of central bankers.  And in a world where markets were truly free and where everyone competed on a level playing field, I am 100% in agreement with that view.  Alas, I’m not sure if you noticed, but that is not the world in which we live.

If Covid taught us nothing else, it was that 40 years of globalization and creating the most efficient processes for manufacturing resulted in significant fragility in those very processes.  It turns out that while economists in the US, Europe, Japan, the World Bank and IMF all explained that this was a great outcome (the US prints paper notes and gets lots of stuff for it), that only works when there is peace on earth.  During this period, China chose to play by a different set of rules, explaining they were just a poor country so didn’t need to play by the G10’s rules, and massively subsidized numerous industries while essentially ignoring all environmental issues.  That tilted the playing field pretty aggressively, and while President Trump has been adamant about that very issue for a decade, he was largely ridiculed, right up until Europe recently figured out that China was eating their lunch too, and now they are looking to impose tariffs on China’s excessive exports.  There is an excellent Substack that comes out Sunday mornings called The Brawl Street Journal,written by an analyst in Germany.  This week’s, linked here, explains that very issue extremely well.

So, I’ve set the table here, and the key to understand is the table is tilted horribly, with China getting the benefit of the doubt for almost everything.

Now, let’s consider what Mr Every’s idea would mean.  Below is a chart showing current 10-year yields for Treasuries and a series of corporate bonds delineated by their credit ratings.

Data: streetstats.finance

Makes sense, less creditworthy names pay more.  That is how things have always been within a market system as the worse the credit rating, the higher the perceived risk of the investor and therefore the higher yield they demand.

But what if that were to change?  What if the Fed and Treasury decided that companies that manufactured products, be they semiconductors, automobiles, tractors, airplanes or flat panel screens, and mining companies that mined in the US (and Canada) and energy extraction companies that drilled in the US (and Canada) needed a lower cost of capital to be more competitive globally as those companies were the ones necessary for the US to maintain its global hegemon status.  But media companies, and retailers, non-bank financial institutions and home health services companies, for example, were not deemed as critical.  Perhaps the new “credit” curve might look like this instead (all hypothetical)

The point is, China has been subsidizing numerous manufacturing industries for decades with the goal of excess production designed to drive other nations’ competitors out of business and gain a strategic advantage in all those industries.  It is why President Trump’s tariffs were a problem for them, and the rest of the world, as the US had been the dumping ground for much excess Chinese production in the past, and now that stuff is going elsewhere.  

The world we once knew is no longer the world in which we live.  Mr Every’s term, economic statecraft, is much more applicable today than any time in the past 40 years, probably longer, since the end of WWII.  Statecraft implies nations will use all the power they have, economic, military and diplomatic, to achieve their desired goals.  For more than 70 years, the US did not play by those rules under the assumption that if they created a level playing field, and even tilted it in favor of weaker allies, peace would reign.  China doesn’t play by those rules, and that is how we have arrived where we are.  

This is all hypothetical, but remember, Chairman Warsh has talked about restructuring the Fed.  All the economists think he is talking about shrinking the balance sheet.  But what if he is talking about completely changing credit markets with Fed support?  I would argue that is not on many bingo cards.

So, briefly, let’s consider how markets would respond to this action by the ‘new’ Fed.  Here are my conclusions, I would love to hear yours.

  • Stocks – broadly lower, although clearly favored sectors would continue to perform well.  But overall leverage would shrink and that has been a huge part of this rally.
  • Bonds – a steeper Treasury yield curve seems certain as subsidies for those favored industries will weigh on the US budget.  Meanwhile, non-favored industries would find themselves with real difficulties in terms of financing.
  • Commodities – offsetting forces here as industrial metals would see increased demand, and getting supply on line takes years if not a decade, but energy may result in a glut sooner as drilling takes much less time to get going.  Precious metals would soar, I believe, on the basis of investors and central banks, seeking an asset with no counterpart.
  • FX – this is the toughest call as different nations will be impacted in very different manners.  Commodity producing nations (e.g., Chile, Norway, US) should see relative strength.  Consuming nations would likely suffer somewhat, although Japan and Korea, for instance, could essentially fall within the US umbrella as their key industries are the US focus.

Again, this is all hypothetical but is probably worth some thought.  In the meantime, a brief tour of markets overnight after Friday’s sharp declines in the US shows nobody is very happy this morning.  The tradingeconomics.com screenshot below shows futures as of 6:10am.

What sticks out to me is Italian equities are bucking the trend, although there has been no data and I cannot find a specific catalyst there.  Also, it is interesting that US futures are broadly higher this morning despite growing concerns that the situation in the Gulf is going to heat up again.  But Asia had a rough session and most of Europe is feeling a little pain as well.

In the bond market, after climbing on Friday, yields continue higher this morning across the board.  The below Bloomberg screenshot explains things well.  Recognize that Canadian and Mexican markets haven’t opened yet and Australian markets were closed last night for the King’s Birthday.  But net, there is growing concern over inflation on a worldwide basis it appears.  

Turning to the commodity markets, oil (+3.8%) is higher again, after falling on Friday as there were missile attacks by Iran on Israel in response for Israel’s ongoing attacks on Hezbollah in Lebanon. This situation remains fraught and frankly nobody has any idea when it will settle down into something a bit less volatile.  If we look at a chart of the past six months of oil price movement, I have drawn a line at $95/bbl, which to my eye offers a pretty good estimate of the average since things began.  There are still many doomsayers who believe $200/bbl oil is coming soon, but that has been their forecast since March.  Something to remember about commodity markets is that they do not forecast the future, they are the prices at which physical stuff clears, so it appears that so far, there is ample inventory available.

Source: tradingeconomics.com

Not surprisingly, given the recent relationship between gold and oil, the barbarous relic is lower this morning by -0.7% while silver, though unchanged on the day, suffered dramatically on Friday, falling $6/oz or about 8%.

Finally, the dollar is little changed this morning, but that is after a sharp rally on Friday in the wake of the much better than expected NFP data (+172K with revisions higher in the previous two months of +93K) which helped push yields higher as a rate hike this year has now been priced by the futures market as per the below CME table.

But more than just the futures market is thinking that way.  The below chart showing the 2-year Treasury vs. Fed Funds shows that not only have 2-year yields moved above Fed funds, but they are accelerating higher.  This is seen as another harbinger of a higher Fed funds rate.

Source: tradingeconomics.com

So, the DXY is back over 100.00, USDJPY breeched 160.00, and is right on that number as I type at 6:50am, and generally, the dollar is pushing the top of its recent ranges.  The one exception here is KRW (+1.6%) where the central bank and Finance Ministry both were actively jawboning the currency higher after it traded to yet another new low (dollar high).

As there is no data of note this morning, I will go through that tomorrow given how long things got today.  The world is changing rapidly and the most important thing, I think, is to recognize that old relationships may no longer be valid.  Nimbleness is critical, whether investing or hedging.

Good luck

Adf

The Strait’s Dead

Posted on by 
The president’s on his way home
And pundits with TD Syndrome
All say that the trip
Did not flip the script
And still see the world in a gloam

But markets, one thing, seemed to hear
That though China wants Hormuz clear
The President said
To him the Strait’s dead
And markets responded with fear

With President Trump on his way back home from his trip to Beijing and meeting with Chinese President Xi, we can now expect reams of stories about all the things that he either did or didn’t accomplish.  Much has been made of Xi’s opening comments about Taiwan and how it is a critical issue that cannot be mishandled or it would impact the relationship between the two nations.  But as I think about Taiwan and China, I certainly understand Xi’s interest in having the island reintegrate into China as it would bring an enormous number of technological skills and abilities in areas currently absent on the mainland.  And, of course, Xi will point to history and claim it has always been part of China, yada, yada, yada.

However, ask yourself why any Taiwanese would want to become part of China.  After all, per capita income in Taiwan is ~$42K annually compared to ~$14K on the mainland.  That is a serious reduction in living standards.  Add to that the ability to vote in free elections and the accompanying belief that one’s voice can be heard, and that is a powerful argument to remain independent.  Now, as TSMC builds out is fabs in Arizona and elsewhere in the world, it seems to me that the US will lose interest in the Taiwan independence issue overall because, especially for President Trump, who views almost everything transactionally, if the US can get its semiconductors from elsewhere with no problems, notably domestically, defending an island on the other side of the world, one that is decidedly not in the Western Hemisphere, seems far less critical. 

Here’s a forecast, by the end of Trump’s term, with TSMC fabs up and running in Arizona, Japan and even Germany, we can see a Taiwan deal similar to the Hong Kong deal, which will sound great but over time China will absorb it in the same way it has done Hong Kong, removing freedoms and its appeal as a manufacturing center.

On to the other part of the trip that has had a much larger impact on markets, when Mr Trump explained, “We don’t need the Strait of Hormuz open.”  While the comments from the trip were that China wants it open and agrees tolls are inappropriate, the last throwaway line is what has markets on edge this morning.  And on edge, they certainly are!

Thus, without further ado, let’s take a look with pictures serving their purpose.  As of 7:15 this morning, here are the major equity index futures from tradingeconomics.com

The caveats here are that Toronto’s TSX and Brazil’s IBOVESPA futures markets are not yet open, but I’m confident both will open lower.  Russia’s MOEX is irrelevant which makes the Swiss Market Index the only equity market anywhere that is not falling.  Perhaps more than the Swiss franc, their stock market has achieved some haven status.

The thing to remember about this sell-off, though, is that we have had a remarkably strong week overall, and so this feels more like a profit taking retracement than the beginning of a new move lower, at least to me.  

In the bond market, sellers are the dominant force with yields higher everywhere around the world as per the below Bloomberg screenshot.

Much has already been written about 10-year Treasury yields trading at their highest level in almost exactly a year, and 30-year Treasury yields now firmly above 5.0% and how that spells the end of the good times in the US.  Maybe that is the case, but I am not convinced.  My take of the biggest problem is in the UK, where PM Starmer is under even more pressure this morning after several moves where a key cabinet member, Wes Streeting, resigned to open his path to run for PM as well as where a Labour party member stepped aside so that the very popular Andy Burnham, who is Mayor of Manchester, can now run for parliament and be in a position to become PM.  The issue here is that since Starmer will do all he can to hold on to his seat, and the Chancellor, Rachel Reeves, is in his corner, we will see even more deficit spending there to try to help Starmer stay in power.  Apparently gilt investors are not impressed with that potential.  Of course, neither is anybody holding pounds as a position as is apparent in the FX markets.

While the pound (-0.25%) is only modestly lower this morning, since Monday, as you can see below, it has fallen 3 cents and does not yet seem to have found a bottom.

Source: tradingeconomics.com

But this is of a piece with the dollar writ large this morning, which is higher virtually across the board.  In fact, as you can see, in what may be my most frequently printed chart to dispel the idea that the dollar is dying, the DXY remains firmly in its range for the past year and is now heading toward the upper band.  If you look at the calculated mean/variance of the DXY, you can see the trend line (the black line in the center) is completely flat, i.e. the dollar is trending neither higher nor lower over the past year.

Source: tradingeconomics.com

Looking at specific currencies, AUD (-1.0%) and NZD (-1.45%) are the worst performers in the G10, although NOK (-0.9%) and SEK (-0.9%) are giving them a run.  Kind of surprising for NOK given oil is much higher this morning.  in the EMG bloc, ZAR (-1.0%), CLP (-1.0%), MXN (-0.8%), and KRW (-0.5%) are the laggards in their respective regions with ZAR suffering from the commodity movements, as is CLP with copper sharply lower this morning.  MXN seems to be reacting to the news that the US has been stepping up its aggressive tactics against the drug cartels there and concerns about how that will end up.

Finally, on to commodities where oil (+3.0%) has responded exactly how you would expect to the Trump comment about his cares about Hormuz.  Meanwhile, the metals are back in full negative correlation mode with oil as all of them are sharply lower this morning (Au -2.0%, Ag -5.9%, Cu -4.3%, Pt -4.0%).  The one thing you have to admit about the commodities markets these days is that they are living up to their reputation of extreme volatility.

On the data front, this morning brings Empire State Manufacturing (exp 7.5), IP (0.3%) and Capacity Utilization (75.8%), none of which typically have a big impact and given the oil/Hormuz fears extant this morning, will almost certainly be completely ignored.  There are no Fed speakers today but I do want to mention one from yesterday, Governor Michael Barr, who directly contradicted everything Chairman Warsh has been saying about the size of the Fed’s balance sheet, explaining that if they move away from their current ‘ample reserves’ model, it could have very negative impacts on the functioning of money markets.

There is an irony here as prior to the ‘ample reserves’ framework, there was a very active Fed funds trading market on an interbank basis and banks were able to borrow from each other whatever they needed for liquidity purposes.  The Fed has usurped that role ever since the GFC and are now clearly concerned (afraid?) about going back.  The thing is, it seems to me that there continues to be a tremendous amount of liquidity around and it would be quite feasible to create an intraday loan market to help alleviate those concerns.  In fact, cash rich corporates (Berkshire Hathaway anyone?) could be part of the market as it would be entirely interbank and those corporates would know the counterparties quite well.  Suffice it to say that Mr Warsh will have quite a time getting his way at this stage.

And that’s what we have going into the weekend.  Gloom and doom about the near future, or profit taking, I’m not sure which.  As I have said all along, play it close to the vest, in think.

Good luck and good weekend

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