Tag Archives: #riskoff

Chaos is Spreading

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Around the world, chaos is spreading
As government norms get a shredding
Korea’s the latest
But not near the greatest
Seems to the Fourth Turning we’re heading

While Russia/Ukraine knows no end
And Israel seeks to defend
The French are about
To toss Michel out
And all this ere Trump does ascend

 

If you view markets through a macro lens, the current environment can only be described as insane.  Niel Howe and William Strauss wrote a book back in 1997 called The Fourth Turning (which I cannot recommend highly enough) that described a generational cycle structure that has played out for hundreds of years.  If you have ever heard the saying 

  • Hard times make strong men (1st Turning)
  • Strong men make good times (2nd Turning)
  • Good times make soft men (3rd Turning)
  • Soft men make hard times (4th Turning)

Or anything in the same vein, this book basically describes the process and how it evolves.  The essence is that about every 20-25 years, a new generation, raised by its parents whose formative years were in the previous Turning, falls into one of these scenarios.  Howe and Strauss explained that at the time they wrote the book, we were in the middle of the 3rd Turning, and that the 4th Turning would be upon us through the 2020’s.  One of the features they highlighted was that every 4th Turning was highlighted by major conflict (WWII, Civil War, Revolutionary War, etc.) with the implication that we could well be heading toward one now.

Of course, we already have a few minor wars with Russia/Ukraine (although that seems to have the potential to be more problematic) and Israel/Hezbollah/Hamas, with Iran hanging around the edges there.  In a funny way, we have to hope this is the worst we get, but there are still more than 5 years left in the decade for things to deteriorate, so we are not nearly out of the woods yet.  

But turmoil comes in many forms and political turmoil is also rampant these days.  This is evident by the number of sitting governments that have been ejected in the most recent elections as well as the increasingly strident blaming of others for a nation’s current problems.  In this vein, the latest situation will happen shortly when the French parliament votes on a no-confidence motion against the current PM, Michel Barnier.  As it is, he is merely a caretaker PM put in place by President Macron after Macron’s election gamble in June failed miserably.  Adding to France’s problems, and one way this comes back to the markets, is that the French fiscal situation is dire, with a current budget deficit exceeding 6% of GDP and no good way to shrink it.  In fact, Barnier’s efforts to do so are what led to the current vote.  I have already discussed French yields rising relative to their European peers and the underperformance of the CAC as well. 

On the one hand, today’s vote, which is tipped to eject Barnier, may well be the peak (or nadir) of the situation and things will only improve from the current worst case.  However, it strikes me this is not likely to be the case.  Rather, there are such a multitude of problems regarding immigration, culture, economic activity and government responsiveness, that we have not nearly found the end.  My fear is we will need to see things deteriorate far more than they have before populations come together and agree that ending the mess is the most important outcome.  Right now, there are two sides dug in on most issues and the split feels pretty even.  As such, neither side is going to give up what they believe for the greater good, at least not yet.

And before I move on to the markets, I cannot ignore the remarkable events in South Korea yesterday, where President Yoon Suk Yeol declared martial law in the early hours on the basis of the opposition’s efforts to paralyze the government (I guess that means they didn’t agree with him).  In the end, the Korean Parliament voted to rescind the order, and the military has since stood down with all eyes on the next steps including likely impeachment hearings for the President.  Not surprisingly, Korean assets suffered during this situation with the won tumbling briefly, more than 2.6%, before retracing the bulk of those losses once the order was rescinded.  

Source: tradingeconomics.com

Too, the KOSPI (-1.5%) suffered although that was off the worst levels of the day after things settled down.  The point to keep in mind here is that markets are subsidiaries of economies.  They may give indications of expectations for the future, or sentiments of the current situation, but if we continue to see geopolitical flare ups, markets are going to respond as investors seek havens.  In this case, the dollar, despite all its flaws, remains the safest choice in many investors’ eyes, so should remain well bid overall.

Ok, let’s look at how markets have been behaving through this current turmoil.  In Asia, given the events in Korea, it ought not be surprising that equities had little traction.  Japanese shares were unchanged as were Hong Kong although mainland Chinese (-0.5%) and Australian (-0.4%) shares were under some pressure.  That said, Australia suffered on weaker than forecast GDP data which puts more pressure on the RBA to cut rates despite inflation remaining sticky.  Australia dragged down New Zealand (-1.5%) shares as well with really the only notable winner overnight being Taiwan (+1.0%).  In Europe, investors seem to be betting on a more aggressive ECB as somewhat weaker than expected PMI Services data has led to gains on the continent (DAX +0.85%, CAC +0.5%, IBEX +0.7%) although UK shares (-0.2%) are not enjoying the same boost.  I guess the French market has already priced in the lack of a working government, hence the market’s underperformance all year.  US futures, at this hour (8:00) are pointing higher by between 0.3% and 0.6%.

In the bond market, yields are rising, with Treasuries (+4bps) leading the way although most of Europe are higher by between 3bps and 4bps.  It has the feel that bond markets are starting to decouple from central banks as they see inflationary pressures building and central banks still in active cutting mode.  I fear this will get messier as time goes on.

In the commodity markets, oil is unchanged this morning, right at $70/bbl, having continued its rally for the week on news that OPEC+ will maintain its production cuts through March 2025.  NatGas (-2.0%) has been sliding since the spike seen 2 weeks ago ahead of the current cold spell as warmer weather is forecast for next week.  In the metals market, gold (-0.2%) seems stuck in the mud right now while silver (-1.3%) and copper (-0.6%) appear to be victims of the dollar’s strength.

Turning to the dollar, it is stronger across the board with AUD (-1.3%) the laggard after that GDP data and it dragged NZD (-1.0%) down with it.  JPY (-1.1%) is also under pressure as hopes for that BOJ rate hike dissipate.  Away from those, the euro (-0.2%) and pound (-0.1%) are softer, but much less so.  In the EMG bloc, ZAR (-0.5%) is feeling the weight of the weaker metals prices and we are seeing BRL (-0.3%) and CLP (-0.1%) also sliding slightly although both are stabilizing after more pronounced weakness earlier in the week.

On the data front, this morning brings ADP Employment. (exp 150K) along with ISM Services (55.5) and then the Fed’s Beige Book.  Perhaps of more importance, at 12:45, Chairman Powell will be speaking and taking questions, so all eyes will be there looking for clues as to how the Fed will be viewing things going forward.  Fed funds futures have been increasing the probability of that rate cut, now up to 74%, which implies we are going to see one, regardless of the inflation story.

Central banks around the world are in a bind as inflation refuses to fall like they want but many nations are seeing slowing economic activity.  In the end, I expect that the rate cutting cycle has not ended, but the dollar is likely to remain well bid given both its haven status and the fact that the US economy is outperforming everywhere else.

Good luck

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Whining and Bleating

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In Rio, the G20’s meeting
With typical whining and bleating
No progress was made
On tariffs or trade
And Trump, though not there, took a beating
 
Seems leaders in most of these nations
Are fearful of future relations
With Trump and the States
Which just demonstrates
How low are their own expectations

 

I guess the idea of these broad talking shops is rooted in a desire to keep open lines of communication between parties with different views on the way things should be in the world.  But, boy, the G20 has really deteriorated over time.  Probably, this is merely a symptom of the underlying changes in international relations.  Remember, the G20 is an outgrowth of the Group of 7 nations (US, Germany, UK, Japan, France, Canada and Italy) and only began in 1999.  The idea was to help develop the globalization initiative by creating an organization that included both developed and developing nations.  It was this group that led to China joining the WTO in 2001 and, ironically, which laid the groundwork for its own slow disintegration.

This is not to say that these leaders are going to stop meeting each year, just that the opportunity for substantive policy proposals has likely passed us by.  And understand, this has been the case for a while now as the Chinese mercantilist policy has seemingly reached the end of its global acceptance.  While President-elect Trump tends to get the most bashing for this, one need look no further than Europe to see tariff and non-tariff barriers rising quickly.  Below, I will allow Bloomberg’s reporters to summarize some of the key issues highlighting the lack of agreement on anything.

  • Germany’s Olaf Scholz and France’s Emmanuel Macron are pushing for tougher language in the summit communique against Hamas and Russia on the wars. Brazil doesn’t want to reopen the text, fearing that it will reignite battles over other issues too. 
  • UK Prime Minister Keir Starmer irritated Chinese officials by raising human rights and the issue of Taiwan with President Xi Jinping at their first bilateral meeting.
  • The potential impact of Donald Trump’s impending return to the White House on trade and diplomatic relations hung over many of the day’s bilaterals. 
  • The rivalry between host Brazil’s Luiz Inacio Lula da Silva and Argentina’s Javier Milei was on full display on everything from the role of the state in fighting poverty to climate change, with the latter leader maintaining his contrarian stance to some of the key points in the summit’s statement.
  • There was even drama around the traditional family photo, which US President Joe Biden, Canada’s Justin Trudeau and Italian Prime Minister Giorgia Meloni somehow missed.

As I said, I expect that these meetings will continue but their usefulness is very likely to continue to deteriorate.  One way you know that this process has reached the end of the road is that no financial markets have reacted to any commentary from anyone at the meeting.  In the past, the G20 statement or comments from leaders on the sidelines would move markets as they implied policy shifts.  No longer.  Remember, too, that at least four of these leaders are lame ducks (Biden, Macron, Scholz and Trudeau) and will be out of office within a year.

Away from the photos and sun
Investors see fear and not fun
Ukraine’s getting hotter
Midst greater manslaughter
While pundits, new stories, have spun

However, if we step away from the glitz (?) of the G20 meeting, markets are demonstrating a fearful tone this morning.  Yesterday saw US equities with a mixed session as investors continue to try to determine the impacts of President Trump’s return.  Will there be tariffs?  If so, how big and on what products?  And which companies will benefit or be hurt by the process.  Generally speaking, the thought has been small-cap companies would be the big beneficiaries while both Big Pharma and Big Food would feel pressure from this new administration.  But how has that impacted other nations and other markets?

In truth, I have a feeling one of the key issues this morning is that President Biden’s change in policy to allow Ukraine to fire long-range missiles into Russia is now a growing concern.  Russia has altered their nuclear response policy, essentially threatening that if this keeps up, they will both blame the US and NATO and respond with nuclear weapons if they determine that is appropriate.  Funnily enough, investors, especially those in Europe, have determined that may not be a positive outcome for European companies.  Hence, bourses across the continent are all lower this morning with declines greater than -1.1% everywhere with Poland (-2.1%) the laggard.  As to Asian markets overnight, they were broadly firmer as the potential escalation in Europe is likely to have a smaller impact there.  But US futures are under pressure this morning, -0.4% across the board at this hour (6:30).

That risk off feeling is being felt in bond markets as well, with yields falling everywhere as investors switch from stocks to bonds.  Treasury yields have fallen -6bps and we are seeing similar declines, between -4bps and -6bps, across the continent as well.  Fear is palpable this morning here.

This fear is clear in the commodity markets as well where oil (-1.0% after a 3.3% rally yesterday) is softer along with copper (-0.7%) but precious metals (Au +0.8%, Ag +0.5%) are both in demand.  The one other noteworthy move this morning is NatGas (+0.6%), bucking the oil trend as despite the oft-feared global boiling (to use UN Secretary General Antonio Guterres term), Europe is feeling an unseasonable cold spell with rain and temperatures just 40° Fahrenheit, some 15° below normal.

Finally, the dollar is back on top this morning as fear has driven investors and savers to holding the greenback despite all its problems.  Using the Dollar Index (DXY) as our proxy, you can see from the below chart that despite all the huffing and puffing that the post-election climb of the dollar had ended last Thursday, in fact, we have only seen a very modest correction of the sharp election move and my take is we have higher to go from here.

Source: tradingeconomics.com

Adding to the risk-off thesis is the fact the JPY (+0.4%) is firmer and CHF (0.0%) has not declined with both of those traditional havens holding up well.  One other note is AUD (-0.2%) is one of the better performers after the RBA Minutes last night indicated that the central bank Down Under is also in no hurry to cut rates with fears of inflation still percolating there.  A quick look across the EMG bloc shows us that virtually all these currencies are softer with PLN (-0.8%) and ZAR (-0.65%) the laggards.  I guess given the concerns over Poland and a potential escalation of the war in Ukraine, it is no surprise the zloty is under pressure.

On the data front, this morning brings Housing Starts (exp 1.33M) and Building Permits (1.43M) as well as Canadian inflation (1.9% headline, 2.4% Median).  There are no Fed speakers scheduled today and quite frankly; it doesn’t strike me that Housing data is critical to decision making right now.  Fear is in the air and that is likely to continue to drive markets.  With that in mind, a deeper equity correction along with continued USD strength seem like the best bets for the day.

Good luck

Adf

A Warning

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Though Trump has been leading the news
With folks asking who he will choose
As agency chiefs
That share his beliefs
For markets, today brings new cues
 
Inflation will soon be released
And though Jay claims he killed this beast
The data this morning
May well be a warning
Inflation, in fact, has not ceased

 

Source: tradingeconomics.com

Beauty (and everything else) is in the eye of the beholder.  So, what are we to make of the above chart which shows the past ten years’ worth of monthly Core CPI readings prior to this morning’s release.  Some eyes will travel to the peak in April 2021 (0.812%) and see a downward sloping line from there.  The implication is that the trend is your friend and that things are going well.  Others will gravitate to the June 2023 print (0.195%) and see that except for a blip lower in June 2024 (0.1%), the series looks like it may have bottomed and, if anything, has found a new home.

Remember, that if the monthly print is 0.3%, that annualizes to 3.7% Core CPI.  That seems pretty far above the 2.0% target that the Fed is shooting for and would call into question exactly why they are cutting interest rates.  In fact, you can look at the above chart and see that prior to the pandemic, core CPI on a monthly basis was below 0.3% every month except one, with many clearly down near the 0.1% level.

As much as Powell and his minions want to convince us that inflation is heading back to their goal and everything is ok, the evidence does not yet seem to be pointing in that direction.  For today, current median analyst expectations are for a headline of 0.2% M/M, 2.6% Y/Y and a core of 0.3% M/M, 3.3% Y/Y.  Even if the data comes as expected, it would seem very difficult to justify continuing to cut rates given the equity market remains essentially at all-time highs, while Treasury yields (-1bp today, +12bps yesterday) seem like they are starting to price in higher long-term inflation.

However, something interesting seems to be happening with the Fed speakers.  Richmond Fed President Barkin yesterday explained that things look pretty good, but declined to even consider forecasting where things will go.  As well, Minneapolis Fed President Kashkari indicated that while inflation has declined, it does not yet seem dead.  The Fed funds futures market is now pricing just a 62% probability of a rate cut in December.  One month ago, it was pricing an 84% probability.  As I have maintained, it seems increasingly difficult for the Fed to make the case that rate cuts are necessary given the economic data that we continue to see.  I understand that there are still a large group of pundits who believe things are much worse when you dig under the surface of the data, and I also understand that most people in the country don’t believe that things are going that well, hence the landslide election results for Mr Trump.  However, based on the data that the Fed allegedly follows, rate cuts seem difficult to support.  Today will be another piece of the puzzle.  If the data is hot, I expect risk assets to suffer more and the dollar to continue its rally.  If the data is soft, look for new records in stocks while the dollar retraces some of its recent gains.

With that in mind, let’s look at what happened overnight in markets.  Yesterday’s modest declines in the US market were followed by more selling than buying in Asia with the Nikkei (-1.7%) leading the way lower but weakness also seen in Australia (-0.75%), Korea (-2.65%), India (-1.25%) and Taiwan (-0.5%) as an indication of the general sense in the time zone.  The outlier here was mainland China (+0.6%) where hope remains eternal that the government will fire their bazooka.  In Europe, though, this morning is seeing a hint of red with most major indices lower by just -0.1% and Spain’s IBEX (+0.2%) even managing a small gain.  The commentary from the continent is over fears of how things will evolve with the new Trump administration and his threat of more tariffs on European exports.

But here’s something to consider.  If Trump is successful in quickly negotiating an end to the Russia/Ukraine war, won’t that be a huge benefit to Europe?  After all, if the war is over, they will be able to restart imports of cheap Russian NatGas which should have an immediate impact on their overall cost of energy, especially Germany, and help the economies there substantially.  I know they love to scream because they all hate Trump, but it seems like he could help them a lot if they would let him.  Oh yeah, US futures are a touch lower, -0.2%, at this hour (7:10).

Anyway, in the bond market, after yesterday’s rout in the US, yields are little changed this morning but in Europe, yields are climbing as they weren’t able to keep up with US yields yesterday.  So, on the continent, yields are higher between 2bps and 4bps after rising 4bps – 6bps yesterday.  In Asia, JGB yields jumped 4bps on the global rise in bond yields and are now back above 1.0%.  However, that has not been nearly enough to help the yen (-0.2%), which continues to weaken and is pushing back above 155.00 this morning.  

In the commodity markets, oil (+0.2%) is edging higher, but that seems to be consolidation after what has been a pretty awful week for the black sticky stuff.  OPEC reduced its demand forecasts for the 4th consecutive month, something else that is weighing on the price and, of course, the Trump administration is going to seek to make it much easier to explore for and produce more oil.  In the metals markets, gold (+0.5%) seems to have found a temporary bottom along with silver (+0.8%) although the damage has been substantial this week.  However, copper and aluminum remain under pressure as fears over continued weakness in China seem to be weighing on the price.

Finally, the dollar has stopped rising sharply, although it is not really declining very much, at least not vs. the G10 currencies.  In fact, vs. the G10, the dollar is softer by just 0.1% or so vs. the entire bloc other than the yen mentioned above.  However, vs. the EMG bloc, the dollar has ceded some more gains with KRW (+0.7%) the leader but MXN (+0.4%), CNY (+0.35%) and ZAR (+0.6%) all bouncing back after a week of substantial declines.  We all know nothing goes up or down in a straight line, so this consolidation is just that, it is not a trend change by any stretch.  A quick look at the MXN chart below, which is essentially what we have seen everywhere, explains just how insignificant the overnight movement has been relative to the recent trend.

Source: tradingeconomics.com

On the data front, aside from the CPI data, we hear from three more Fed speakers (Logan, Musalem and Schmid) so it will be interesting to see if they are starting to change their sense of how things are going to progress.  Of course, all eyes will be on Powell’s speech Thursday afternoon, but perhaps there are some clues to be had here.

It is not clear to me that anything has changed in the big picture.  The US economy continues to be the strongest one around and now has the added impetus of expectations for more positivity with the change in the administration.  In that environment, my long-term view on the dollar remains it has further to run.

Good luck

Adf

Quite Drear

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The world is apparently ending
‘Cause stocks just will not stop descending
So, calls have increased
For fifty, at least
And government to up its spending
 
The cause of this rout is unclear
Though data of late’s been quite drear
If growth is much slower
Then stocks can go lower
And that, my good friends, triggers fear

 

The only topic on market practitioners’ lips this morning is the ongoing sell-off in equity markets around the world.  The US returned after the Labor Day holiday and sold equities aggressively with the NASDAQ falling more than 3.25% and the other major indices all declining at least -1.5%.  This led to a disastrous opening in Asia with the Nikkei (-4.25%) leading the way down as fears of a repeat of the early August rout were rampant.  While things never got to that point, we did see both Korea and Taiwan markets fall even more than Tokyo with declines between -4.5% and -5.0%.  This negative sentiment is alive and well in Europe with every market lower there, although the declines are less pronounced, between -0.7% and -1.1%, and US futures are lower this morning as well, down anywhere between -0.3% and -0.6% at this hour (6:30).

So, what’s happening?  Is there something new that was previously unknown?  The first place to look is the data which saw ISM manufacturing rise less than expected to 47.2, a number that historically represents recession, with the added problem of the ISM Prices Paid reading at 54.0, higher than expected and a potential harbinger that inflation may not be declining as quickly the Fed expects.  Add to that a weaker than expected Construction Spending result, -0.3%, and you have the makings of some potential dreariness on the economic front.  The problem with this thesis is that the equity market opened prior to the releases and was already down -1.0% by the time they hit the tape.

Perhaps it is simply the end of summer blues as historically, September seems to be the worst month for equity performance, although I don’t put much credence in the idea that just because something has happened at a particular time before in markets, it will happen again.  Seasonality is real, especially in things like commodities, but is technology really seasonal?  And tech was leading the way lower.

Of course, markets have a long history of simply moving up and down over time without any specific catalyst.  Positioning and changes in sentiment evolve over time and sometimes they combine to move markets more than would otherwise be expected.

From a macro perspective, I believe that this week will teach us a great deal as the ISM data along with the employment data will give further evidence of the potential for that widely hoped for soft-landing or whether things are declining more rapidly.  Certainly, we continue to read of problems arising elsewhere in the world with the VW news about potential plant closings and weakness in Chinese PMI data overnight indicating that President Xi may need to do more to support his economy.  The thing about sentiment is that it doesn’t necessarily need a clear catalyst to change.  

Source: Horace.org

In the end, I’m hard-pressed to define anything that has changed since Friday afternoon.  However, it appears that sentiment is clearly far more circumspect about the future of economic activity and how that will be able to support the current extremely high valuations of so many companies.  As Ace Greenberg, then Chairman of Bear Stearns said when asked about what happened in the wake of Black Monday in 1987, “markets move, next question.”  

To this poet’s eyes, the big picture remains that economic activity is continuing to slow down around the world, and that price pressures in the US are lagging that decline.  It appears that China is flooding the global markets with manufactured goods as domestic consumption there remains lackluster, thus goods price inflation remains under control.  However, there is no sign that central banks or governments are reducing the amount of available liquidity which is finding its way into services pricing, and that is a much larger part of the economy, hence likely to sustain inflation readings going forward.  I’m confident the Fed will cut rates in 2 weeks’ time, but I’m also highly concerned that the result will be inflation remaining higher than ‘target’ going forward.  The one thing on Powell’s side right now is the decline in oil, and by extension gasoline (see chart below where gasoline futures fell >15% in August), prices, which will help push headline numbers lower.

Source: tradingeconomics.com

So, how did other markets behave while stocks were getting hammered?  Treasury yields fell 9bps yesterday after the data release and are lower by another 2bps this morning.  Clear risk-off behavior.  In Europe, sovereign bonds are all seeing declines this morning between -4bps and -5bps after declines yesterday as well and even JGB yields are lower by -4bps this morning.  investors are running for the relative safety of fixed income right now.

In the commodity markets, oil (+1.3%) is bouncing off the lows seen yesterday, when WTI traded down to $69.15/bbl briefly, as the recent decline has OPEC rethinking their decision to start increasing supply next month.  You may recall that when they cut production, they kept renewing that decision every few months but were set to slowly increase production again starting in October.  However, the sharp decline in the price of oil has them backtracking now.  The problem is that the evidence of slowing economic activity is weighing on the price here.  I suspect that until there is clear evidence that economic activity is rebounding, oil could remain under pressure.  In the metals markets, they were also sold off sharply yesterday, but have basically stopped declining for now, consolidating those losses.  Gold continues to be the best performer as the combination of risk-off and ongoing central bank purchases are supporting it well enough.  This is clearer if you look at the price of gold in other currencies, where it continues to make new highs.  But the industrial metals will have a difficult road ahead with slowing growth.

Finally, the dollar, after a strong rally yesterday, is little changed this morning.  In fact, most currencies are within a few basis points of their closing levels yesterday with only MXN (-0.35%) and SEK (-0.3%) showing any semblance of weakness while ZAR (+0.3%) and JPY (+0.3%) are the biggest gainers.  The yen story is clearly the haven aspect with Japanese investors bringing funds home.  Both the peso and krona are likely feeling a little pressure from the declines in commodity prices, while the rand has bucked that trend after reporting higher than expected GDP growth in Q2 and higher Business Confidence this morning.

Data today brings the Trade Balance (exp -$79.0B) at 8:30 and then the JOLTs Job Openings (8.10M) and Factory Orders (4.7$, -0.2% ex transport) at 10:00.  We also will see the BOC cut rates 25bps this morning, although nobody is paying much attention to Canada with all eyes on the Fed and ECB.

While a lower opening seems baked in, I wouldn’t be surprised to see a bounce of some sort by this afternoon as market participants seem to have a hard time allowing prices to fall for too long.  But there appears to be ample reason for further equity declines and further risk reduction, which historically has supported the dollar.

Good luck

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Taboo’s Been Broken

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The calendar’s now turned the page
So, summer has moved to backstage
Thus, risk is retreating
And people are treating
The autumn as though it’s a phage
 
Meanwhile, German voters have spoken
And fears are a new trend’s awoken
Political leaning
Is rightward, thus meaning
A longstanding taboo’s been broken

 

Arguably, the biggest story from the long weekend was the voting in two German states, Thuringia and Saxony, where the Alternative for Germany (AfD) won one-third of the vote in each state thus destroying the traditional political calculus.  AfD is the right-wing party that has been described as neo-nazi and fascist regularly by the media (of course, the Republican party in the US has also been described in those same words), but more importantly, represents a complete rejection of the current status quo in Germany.  But perhaps the bigger concern for the German political elite is that an entirely new party, the Sarah Wagenknecht Alliance (BSW) won 15.5% and 11.5% of the votes in those two states respectively.  The BSW is a far-left party that espouses some of the same opinions, notably on immigration, as the AfD.  In other words, nearly half the electorate voted against the traditional parties as apparently people in Germany are not very happy.

To complete this story, the issue is that AfD, with which all parties have sworn against working in the parliament, has enough votes for a blocking minority, meaning they can (and almost certainly will) prevent the appointment of new judges and any constitutional changes that they don’t like.  As I said, the political calculus in Germany has changed significantly.  In fact, the parties in the current federal coalition (SPD, FDP and the Greens) saw their share of the vote fall to just 10.3% and 12.4%, respectively, in the two states.

I highlight this issue because it is indicative of the ongoing changes in Europe that may well undermine the single currency’s potential, and assumed, future strength based on the dollar’s assumed future weakness.  After all, whether or not the Fed embarks on a long period of rate cutting, or simply implements a token cut or two, given the political upheaval in Europe, is that going to be a good place for industry to invest?  Their energy policies have been hugely counterproductive, and Europe has about the most expensive energy in the Western world.  In fact, Volkswagen AG, has indicated it may be closing plants in Germany for the first time in the company’s long history.  It has simply become too expensive a place to do business.

This is not to imply that the euro (-0.25%) is going to collapse imminently.  Germany is only one of twenty nations in the Eurozone, albeit the largest economy by far.  But the story in Germany is not isolated to that nation.  We have seen similarly poor energy decisions and similar voter responses in other nations (notably the Netherlands, France and Austria). Whatever you think about the dollar, it is very difficult to get excited about the euro in my view.  

But let’s turn our attention to risk writ large.  I keep reading that September is historically the weakest month in the US equity markets and given the number of sources of strong repute that have written such, am willing to take that at face value.  As well, apparently, US households are the most bullish equities, or at least have the largest equity positions as a portion of their assets, in history (see chart below from @InvariantPersp1 on X).

It strikes me that the combination of extreme long positioning and a historical tendency for weakness may open up some downside in the equity markets, at least for a period.  Of course, if you are old enough to remember the yen carry trade debacle all the way back at the beginning of August, you know that even if we see a big downdraft, it can be reversed quite quickly.  And given both the Fed and ECB (and BOE) all meet later this month, it is not hard to believe that if equities were to decline sharply before their meetings, we could see larger than expected rate cuts across the board.  For now, the market continues to price a one-third probability of a 50bp cut by the Fed while expectations are for the ECB to cut in September and a 50% probability of an October cut.  

Net, do not be surprised if September has nearly as much volatility as August as the idea of max-long equity exposure into a slowing economy with still high inflation feels like a tenuous position.  We shall see.

Ok, let’s try to catch up to overnight activity, which has generally been of the risk-off variety.  Since Friday’s close, the story has been more negative than positive with Japanese (-1.1%) and Chinese (-1.5%) markets falling amid slightly softer than expected data and a more general malaise.  In Europe, too, things have been soft with today’s declines ranging from -0.2% (CAC) to -0.8% (Spain’s IBEX) and everything in between.  This is completely in sync with US futures markets which are all lower by at least -0.6% at this hour (7:20).  

Interestingly, while risk is under pressure, the traditional havens of government bonds are not seeing much benefit with Treasury yields edging higher by 1bp and similar moves throughout much of Europe although both Gilts and Bunds have seen yields edge lower by 1bp.  JGB yields have also edged higher by 1bp and are creeping, ever so slowly, back toward 1.00%.  This follows comments by BOJ Governor Ueda that he really means it when he says they BOJ will normalize policy.  The caveat is that will occur only if the economy meets their expectations with growth rising and inflation remaining high.  However, inflation continues to be fairly stable with services inflation actually declining there, thus undermining his message somewhat.

In the commodity markets, oil (-2.3%) has been taking it on the chin for the past week as the combination of the weaker demand story on a slowing global economy combines with growing confirmation that OPEC+ is going to end their production cuts starting next month, thus adding to supply, has weighed heavily on prices.  Back in January, I wrote a piece discussing my change of view on the long-term prospects for oil prices, which I flipped from bullish to bearish.  The essence of the piece was that there is plenty of oil around, it is political decisions that prevent its extraction.  As the politics of everything around the world continues to quickly change, I think this is an important baseline to keep in mind, although that doesn’t mean we won’t see short term spikes in oil’s price.  However, right now, it looks awful on the charts.

As to the metals markets, they have been under some pressure lately as well, notably copper and silver, with each of those falling more than 5% in the past week.  Gold, however, continues to find buyers as the bigger picture concerns of monetary debasement combine with still active central bank purchasers to support the barbarous relic.

Finally, the dollar is quite strong this morning, rallying against almost all its counterparts.  The commodity bloc are the laggards with AUD (-0.8%), NOK (-0.75%), NZD (-0.7%) and SEK (-0.5%) all suffering in the G10 with only JPY (+0.5%) rallying, arguably playing its haven role.  In the EMG bloc, ZAR (-0.8%), and the CE4 (-0.5% each) are under pressure along with KRW (-0.4%) and even CNY (-0.2%).  LATAM is the surprise with MXN (-0.1%) little changed at this hour.

On the data front, this is a big week that culminates in the payroll report on Friday.

TodayISM Manufacturing47.5
 Construction Spending0.0%
WednesdayTrade Balance-$78.9B
 JOLTs Job Openings8.10M
 Factory Orders4.6%
 -ex Transport-0.2%
ThursdayADP Employment145K
 Initial Claims230K
 Continuing Claims1870K
 Nonfarm Productivity2.4%
 Unit Labor Costs0.9%
 ISM Services51.1
FridayNonfarm Payrolls165K
 Private Payrolls138K
 Manufacturing Payrolls0K
 Unemployment Rate4.2%
 Average Hourly Earnings0.3% (3.7% Y/Y)
 Average Weekly Hours34.3
 Participation Rate62.6%

Source: tradingeconomics.com

Obviously, all eyes will be on NFP as the Fed has clearly turned its primary attention to the employment side of its mandate.  However, don’t fall asleep on the JOLTs data tomorrow, as that has also been part of Powell’s calculus. (seems there was a lot of calculus today, I hope you all managed to get through that in college 😂).  Remember, too, that CPI comes next week and then the FOMC meeting is the following week, so there is no respite.

This morning, risk feels unwanted.  With equity markets still within spitting distance of their all-time highs, it appears there is ample room for some down days ahead.  Of course, Friday will be key.  Regarding the dollar, for now, I believe the bounce continues.  But Friday will dictate the medium term, at least until the FOMC meeting.

Good luck

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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

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The World is Ending

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The world is ending
At least, that’s the way it feels
Owning equities
 
The narrative writers are caught
‘Cause stories those writers had wrought
No longer apply
And folks now decry
The idea that dips should be bought
 


Remember the idea of the summer doldrums where everybody is on vacation, so markets move very little? Yeah, neither do I!  Here’s a different idea though, when risk is under pressure, all correlations go to 1.0.  Look at the following three charts (source: tradingeconomics.com) and explain to me how they behave independently:

There is rioting in the streets today, perhaps not in your neighborhood directly, but in many places around the world (the UK, Bangladesh, Kenya, others), as the global order that we have known for the past X years gets tested.  How big is X?  There will be many different answers to that question, but in this poet’s mind, what we are witnessing in its full glory today is the beginning of the unwinding of the market excesses that began when global interest rates headed to 0.00% in the wake of the GFC in 2009, so X=15 years.  

It is easy to wax philosophical on this subject, discussing the merits of moderating the business cycle and why interest rate policy is a net benefit, and you can be sure that before this week is over, we will get policy interventions.  But ultimately, markets need to clear to function effectively, and I would argue that the last time markets actually cleared was in 1974.  The next big opportunity to allow markets to clear was in October 1987 and the Maestro, although he had not yet earned that moniker, stepped in after that Black Monday and promised unlimited liquidity to prevent too much damage. 

Ever since then, central bankers around the world, led by the Federal Reserve, but do not forget actions like Mario Draghi’s “whatever it takes” moment, have decided that they need to manage the global economy, and market responses, and that markets were only effective if they were going higher.  (It’s ironic that TradFi people scoffed at the crypto maxim ‘number go up’, yet they believed exactly the same thing, only in a different wrapper.) As well, we all know that the concept of political will does not exist anymore, at least not in the West, as no elected politician will ever choose to fight for a policy that has short-term pain and long-term gain.  The result of this constant intervention and guidance from policymakers is that things get overdone, and bubbles inflate.  And it is much easier to inflate a bubble when you maintain policy rates at 0.00% (or negative rates in some cases).  

At this point, you will read many stories about which particular catalyst drove this market reaction, whether it was last week’s BOJ meeting where Ueda-san surprised the market and hiked rates as well as promised to reduce QQE, or whether it was the fact that Chairman Powell did not cut rates, or if it was the weak payroll report.  Others will point to the escalation in hostilities in Ukraine and the Middle East as flashpoints getting people to exit risk positions.  But in the end, the catalyst is not important.  As I wrote on Friday, and is so well explained in Mark Buchanan’s book, Ubiquity, the market was rife with ‘fingers of instability’ and an avalanche has begun.

To this poet’s eye, there needs to be more excess wrung from the market.  After all, given the underlying trade of virtually the entire bull market has been the JPY carry trade, where traders and investors borrowed JPY at 0.00%, converted it to another currency and either held that currency to earn the interest rate differential, or for the truly aggressive, used the currency to buy other risky assets (NVDA anyone?), and that trade has been building for years.  Deutsche Bank has estimated that it grew to $20 trillion in size.  I assure you it is not completely unwound!

However, as I mentioned above, I am confident that central bankers are already getting intense pressure from their respective governments to ‘do something’ to stop the rout.  But central bankers are already (save Japan) in cutting mode.  And the Fed just passed on cutting rates last week.  If they were to cut today, no matter what they said, it would remove any doubt that the only thing they care about is the stock market.  It would destroy whatever credibility they still retain.  But do not count out that response, at this stage, it’s probably 50:50 they cut this week if things continue.  After all, the Fed funds futures market is now pricing in a 95% probability of a 50bp cut in September and a total of 125bps of cuts by December!

I will be the first to say I have no idea where things are going to head from here because while market internals point to further unwinding of risky assets, policy responses have not yet been seen.  So, the best advice I can offer if you are not leveraged is do not panic.  If you are, you have probably been stopped out already anyway.  In the meantime, let’s take a look at the damage overnight.

Equity Markets in Asia:

  • Nikkei 225       -12.4%
  • Hang Seng       -1.5%
  • CSI 300            -1.2%
  • ASX 300           -3.7%   
  • KOSPI               -8.8%
  • TAIEX               -8.3%
  • Nifty 50           -2.7%

In other words, it was quite the rout, with tech shares getting hammered everywhere.  Perhaps the most surprising thing to me as that the CSI 300 didn’t fall further, although I suspect that there was significant intervention by the government to prevent that from happening.  (After all, you don’t need to be a western government to want the number to go up!)

Equity Markets in Europe:

  • DAX                 -2.6%   
  • CAC                 -2.4%
  • FTSE 100         -2.4%
  • IBEX                 -2.8%’
  • FTSE MIB         -3.0%

This tells me that these markets were not nearly as leveraged as Asian markets, likely because prospects throughout Europe have been relatively less interesting to many investors.  After all, if you are leveraging up via borrowing yen, you want to buy growth, not value, stocks, and there aren’t that many growth names in Europe.

Finally, US futures, at this hour (7:00) are lower by:

  • S&P 500          -3.0%
  • NASDQ            -4.5%
  • DJIA                 -2.1%

Bond markets are also seeing very significant movement, in the opposite direction as they are performing their safe haven role brilliantly today.  While the movements today are solid, with Treasury and European sovereign yields all lower by between 5bps and 7bps, to see the real story, you need to see the move since Friday’s opening (these are all 10-year yields).

  • US                    -20bps
  • Germany         -10bps
  • UK                   -9bps
  • Japan               -20bps
  • Australia          -17bps

The US yield curve, at least the 2yr-10yr measurement, is virtually flat today and 30yr yields are now higher than both of those maturities.  Also, look at JGB yields, down to 0.77%, as Japanese investors take their toys and go home.  The thing about this move, and the reason I don’t believe the unwinding is over yet, is that once the Japanese investment community starts to move, it takes a long time for them to get to be where they want given the amount of the assets involved.  And despite all the clutching of pearls about the US ability to sell the amount of debt they need to fund themselves; it won’t be a problem for right now.  Many people around the world will be all too happy to buy Treasury bonds regardless of some political foibles in the US.

Commodity markets are under pressure this morning, but not seeing the same type of pain as equity markets. The story here is that commodities are not directly impacted by the current movements (if anything declining interest rates should help them) but when margin calls come, people sell whatever they can that is liquid.  So, gold (-1.6%) is being liquidated to cover margin calls, not because people don’t want it.  Oil (-1.6%) is likely feeling pressure because these equity moves presage potential economic weakness and a reduction in demand, and we are seeing the same response from the industrial metals.  My take is gold is the one thing, besides bonds, that people are going to be willing to hold, and will rebound first.

Finally, the dollar is under pressure, net, but we are seeing massive movements in both directions.

  • JPY       +2.5%
  • EUR     +0.4%
  • GBP     -0.3%   
  • AUD     -0.9%
  • MXN    -3.3%
  • NOK     -1.0%
  • ZAR      -2.0%
  • CNY     +0.8%  
  • CHF      +0.8%
  • KRW    -0.5%

See if you can determine which were the favorite currencies to hold long against short JPY (AUD, MXN, ZAR). Meanwhile, the renminbi is able to gain as it continues to weaken, net against the yen, its most important competitor.  Remember, currencies are the outlet valves for economies when other markets cannot move enough.  The thing to keep in mind, especially as a hedger, is that volatility is going to be very high for a while yet.  This will not all quiet down and go away in a week’s time. 

At this point, it’s fair to ask, does data matter anymore?  Probably not today, but it will be key for the central banks if for no other reason than to cloak their actions in some fundamental story.  Alas for the Fed, there is virtually nothing to be released this week.  All we see is:

TodayISM Services51.0
TuesdayTrade Balance-$72.4B
ThursdayInitial Claims250K
 Continuing Claims1880K

Source: tradingeconomics.com

As well, and perhaps remarkably, so far on the calendar we only have three Fed speakers, Goolsbee, Daly and Barkin.  However, it seems almost certain we will hear from others, especially if the rout continues.

Right now, fundamentals do not matter.  My sense is we will see a bounce of some sort after the first wave ends, perhaps as soon as tomorrow, but the narrative of the soft landing has been discarded.  Look for more political pressure on the Fed to act, and to act soon.  Also, do not be surprised if the rest of the week ultimately sees a slower, but steady, decline in risk assets as those who haven’t panicked react to the situation and reevaluate just how much they love their positions.  Consider, Warren Buffet sold some of his favorite positions last week and is loaded with cash to act.  But there is nobody who is more patient than he.  

Good luck

Adf

Destined for Sloth

Posted on by

The Chinese are starting to worry
That if they don’t act in a hurry
Their ‘conomy’s growth
Is destined for slowth
Explaining their rate cutting flurry

 

Sunday night, the PBOC surprised markets by cutting both their 1-year and 5-year Loan Prime Rates by 10 basis points each.  As well, they cut the rate on their newly developed 7-day repo rate by 10bps as they endeavor to shorten the maturity of their money market operations. At the time, it was taken as a response to the Third Plenum and the only concrete action seen as new support for the economy.  As its name suggests, those rates represent the cost to borrow for credit worthy companies.  A quick look at the history of this rate (the blue line), which was first tracked toward the end of 2013, shows that over time, it has done nothing but decline.  I have overlayed a chart of USDCNY in the chart (the grey line) to help appreciate the long-term trend in that as well which, not surprisingly, shows a steady weakening of the renminbi (rise in the dollar).

Source: tradingeconomics.com

But the reason I bring this up is that last night, the PBOC surprised markets yet again by cutting its One-Year Medium-Term Lending Facility by 20 basis points, to 2.30%.  Not only was this the largest cut since the pandemic, but it was also done at an extraordinary meeting and combined with an injection of CNY235 billion (~$32B) into the economy.  Arguably, this is the most aggressive monetary policy stance that has been effected by the PBOC since the summer of 2015 when they surprisingly devalued the renminbi 2%.  Apparently, the PBOC is trying to adjust its policy actions to be more in line with the G7 where central banks use short term rates as their tools.  One other thing this implies is that President Xi remains steadfastly against any fiscal stimulus of substance at this point.  On the one hand, you must admire that effort, but I fear that the domestic Chinese economy remains so weighed down by the ongoing property sector problems, achieving their 5.0% GDP growth target is going to become that much more difficult as the year progresses.

For our purposes, though, the story is all about the CNY (+0.7%), which rallied sharply after the announcement, continuing its movement from the Monday rate cuts which totals 1.1%.  Now, ordinarily one might think that a country cutting its rates would lead to a weaker currency, ceteris paribus, However, given the market outcome, there is much discussion about how the PBOC “requested” Chinese banks to more aggressively buy CNY to support the currency.  Interestingly, the fixing rate on shore overnight (7.1321) continues to weaken ever so slightly overall, but now the spread between the fix and the market has fallen to just over 1%, well within the +/- 2% band and an indication there is less pressure on the currency.  My take is this is just window dressing, but I would not fight it.  I expect that we will see USDCNY slowly return to higher levels over time, with the key being it will take lots of time.

The ongoing rout
In tech stocks has another
Victim, dollar-yen

Under the guise, a picture is worth a thousand words, the below chart showing the NASDAQ 100 (blue line) and USDJPY (green line) overlaid is quite interesting.

Source: Tradingeconomics.com

While there is an ongoing argument amongst market practitioners as to whether it is the decline in the tech sector that is driving USDJPY’s decline or the other way round, what is clear is that there is a strong correlation between the two.  If you think about what the USDJPY trade represents, it is the purest form of a carry trade, shorting the cheapest currency and using the funds to buy a much higher yielding currency with maximum liquidity.  But another thing to do with those funds obtained from borrowing yen and buying dollars was to use the dollars to jump on the tech stock bandwagon.  After all, that added another 30% to the trade since the beginning of the year.  

However, over the past two weeks, nearly one-third of the NASDAQ gains have been erased and that has been made worse by the >6% rise in the yen.  At this stage, it no longer matters which is driving which, the reality is that we are seeing significant short covering in the yen with sales in other assets required to unwind the trade.  Arguably, this is why we are seeing virtually every risk asset lower this morning, although bonds are holding up as havens, as all have been funded with short yen.  Given that relationship, I am coming down on the side of the yen being the driver, but as I said, I don’t think it matters.  

The real question is can it continue?  It is important to understand that when markets achieve excessive levels like we saw in USDJPY, they rarely simply unwind to some concept of fair value.  Rather they typically overshoot dramatically in the other direction.  As such, if we assume PPP is fair value, and PPP for USDJPY is currently around 110.00, it appears there is ample room for USDJPY to decline much further.  Consider, this movement has happened, and the Fed has not even started to cut rates.  If we do, indeed, fall into recession, the Fed will respond, and I expect that we could see a very sharp decline in USDJPY.  Something to consider looking ahead.

While that was a lot about the currency markets, they seem to be the current drivers, so are quite important.  But let’s look at everything else.

Equity market pain has been universal with Japan (-3.3%), Hong Kong (-1.8%) and China (-0.6%) all following the US lower overnight and in Europe, this morning, it is no better with the CAC (-2.2%) the worst performer, but all the major indices falling sharply.  US futures are little changed at this hour (7:00), but remember, we are awaiting key GDP data and more earnings numbers, which have been the driver.

As mentioned above, bond markets are rallying with Treasury yields lower by 5bps and most European sovereigns seeing declines of -3bps or -4bps.  Credit is an issue as Italian BTPs are the laggard this morning, with yields there only lower by 1bp.  Equally of interest is the fact that the US yield curve inversion has been reduced to just 14bps and has been normalizing dramatically for the past several sessions.  One thing to remember about the yield curve is that when it inverts, it indicates a recession is coming, but when it uninverts, it indicates the recession has arrived!  This is all of a piece with softer economic data and expectations of Fed policy ease coming soon to a screen near you.

In the commodity markets, nobody wants to own anything.  Oil (-1.3%) is continuing its recent poor performance despite EIA data showing significant inventory reductions.  This is not a sign of strong demand.  But we are also seeing weakness across the entire metals space with gold (-1.0%) breaking back below $2400/oz and silver and copper under severe pressure.  Right now, nobody wants to hold these, although I suspect that the long-term supply/demand situation remains bullish.

Finally, the dollar is mixed overall.  While we have seen strength in JPY and CNY, as discussed above, and CHF (+0.8%) is also showing its haven status and use as a funding currency, there are numerous currencies under pressure, notably AUD (-0.8%), NOK (-0.8%), MXN (-0.8%), ZAR (-0.7% and SEK (-0.6%) all of which are commodity linked to some extent.  Yesterday, the BOC cut rates by 25bps, as expected, but the Loonie has been steadily weakening for the past two weeks, so yesterday’s decline and today’s is just of a piece with that.  Ultimately, we are watching a serious risk-off event, and I expect the dollar will hold its own vs. most currencies, although JPY and CHF seem to have room to run yet.

On the data front, once again yesterday’s data was on the soft side with the Flash Manufacturing PMI falling to 49.5, well below expectations and New Home Sales slipping to 617K.  In fact, it is difficult to find the last strong piece of data, perhaps the ex-autos Retail Sales number from last week.  This morning, we see Initial (exp 238K) and Continuing (1860K) Claims, Q2 GDP (2.0%), and Durable Goods (0.3%, 0.2% ex transport).  The Atlanta Fed’s GDPNow tool is indicating GDP in Q2 was 2.6%, well above the forecasts.  However, I think of much more interest will be to see how it starts out for Q3.  We have had a spate of weak data, and those recession calls are growing louder.

This is a tough market, but I expect we have not yet seen the last of the risk-off trade (just consider how long the risk-on trade has been going on) so further dollar strength against most currencies, except for JPY and CHF, and further weakness in commodities and equities seem the most likely direction.

Good luck

Adf

A Bruising

Posted on by

While many consider AI
The future, and can’t wait to buy
The stocks that convey
The future’s today
Perhaps that result’s not yet nigh
 
For instance, today’s biggest news
Is Windows is stuck with, screen, blues
What’s happened is that
A bug, not a gnat
Disrupted what most people use

Oops!  That seems to be the response so far by Microsoft and Crowdstrike as they try to troubleshoot and fix an apparent bug in the most recent release of their software.  The result of this bug is that computers all over the world that use Microsoft Windows as their operating system have, this morning, the dreaded ‘blue screen of death’, something with which far too many of us are familiar.  This problem has affected airports, airlines, banks and businesses of all stripes, essentially shutting down key processes and by extension the businesses themselves.  And consider, this is allegedly because of a single bug in a new rollout of security software.
 
We all know that bugs are an inherent part of the computing world, and most of us have lived through glitches in the past.  The difference this time, though, is that as more and more businesses move more and more of their computing operations into the cloud, the impact of any imperfection in the computer code grows exponentially.  This will not stop the migration of business operations to the cloud, of that I am certain.  But perhaps it will force some businesses to rethink what it means to be secure.
 
Additionally, given the hype surrounding AI, and the growing belief amongst a subset of businesses and investors, that companies which are not utilizing AI are going to wither and die due to its absence, perhaps this situation will cause some to rethink the pace of that utilization.  Remember, the essence of the AI hype is that the computers will be able to replace humans in many jobs, thus increasing efficiency and with it, profitability.  However, not only is the jury still out, but I would contend it has not yet started deliberations as; to date, I have not seen a single application where the results from AI are so superior to human actions, that the vast expenses to train and run AI applications make economic sense.  There is no killer app. 
 
Rather, the best analogy I have seen is that AI represents an advance similar to Microsoft Excel, where prior to the existence of spreadsheets, calculations by hand were incredibly time consuming and correspondingly expensive, but once Excel came along, analyzing data became a routine and much less expensive task.  The difference is Excel was cheap to buy and didn’t use much power to run.  AI is hugely expensive to train and then to run as well.  And bringing this full circle, removing operations from human oversight opens the door to situations like today, where things just don’t work.  Also, consider that Nvidia has sold ~$60 billion of chips in the past year, which means that companies like Microsoft, Alphabet, Apple and Meta have spent that much money on those chips as they build out their AI capabilities.  However, their revenues have not increased by nearly that much, certainly not from any AI initiatives.  Maybe the “killer” in killer app refers to what it is going to do to company profitability for those firms trying to lead this charge.
 
And, since this is a note about money and finance, let’s consider one other issue, the drive by many governments to eliminate cash.  Consider how things would be if cash was gone and all payments were electronic, but then a bug in the system resulted in banking and payments software shutting down.  Exactly how will firms conduct business?  I’m not talking about large-scale manufacturing operations, but rather about the grocery store or the McDonalds or pizza place where you want to get something to eat.  If there is no cash, what do you do?  Money is truly a remarkable invention and until the point when computer systems work 100% of the time, not 99.9%, the absence of a physical medium of exchange has the potential to be devastating to many people if the network goes down.  Just sayin’.
 
For many it was quite confusing
That stocks could absorb such a bruising
But data keeps hinting
That nobody’s minting
More profits, they just might be losing
 
Ok, let’s take a look at markets as we try to prepare for today’s activities.  It seems that as of 7:00am in NY, the bug has been fixed and things are starting to get back to normal.  But this is going to leave a mark.  Yesterday saw the first down day across the board in US markets in weeks with the DJIA (-1.3%) leading the way lower.  Most of Asia followed this move although Japanese declines (Nikkei -0.2%) were mitigated by the release of CPI data that showed no acceleration in prices in Japan.  The Hang Seng (-2.0%) reflected the tech sell-off and equities throughout the region were lower with one exception, mainland Chinese shares rose 0.5% after the end of the Third Plenum.  While many had hoped for some new economic stimulus, it seems that President Xi believes he is already on the right path and will not change.  As to European bourses, they are all lower this morning, following the trend started in the US yesterday while US futures are little changed right now.
 
Treasury yields, which traded higher during yesterday’s session despite the sharp sell-off in stocks, are unchanged this morning and European sovereigns, which closed before the full move was complete in the US have edged up the last 1bp to 2bps to maintain their relative spreads.  The ECB left rates on hold, as universally expected, but Madame Lagarde disappointed the doves by not promising a cut in September.  Despite weakening growth on the continent, inflation remains uncomfortably high it seems.  The same is not true in the US, though, where more Fed speakers gave the same message that things are going well, they are watching unemployment, and a rate cut is likely coming in the not too distant future.
 
In the commodity markets, oil edged lower yesterday after a nice rally Wednesday, and is continuing that this morning, down a further -0.5%.  But the pain trade is in metals with gold (-1.2%) and silver (-1.8%) leading the way lower on what appears to be some market technical issues rather than specific fundamental questions.  Both copper and aluminum are also softer this morning, but that is reflective of the continued concerns over economic growth.
 
Finally, the dollar is firmer again this morning, despite the modestly more hawkish discussion from the ECB and despite the ongoing belief that the Fed is preparing to cut rates at the September meeting.  Yesterday saw some impressive movement with BRL (-1.0%) and CLP (-2.0%) amid that broad-based dollar strength.  However, this morning, the worst performers are SEK (-0.6%) and NOK (-0.4%) with the rest of both the G10 and EMG blocs within 0.2% of Thursday’s closing levels.  The NOK is clearly following oil lower, and SEK is following NOK, as there has been no news or commentary from either nation that would offer a solid rationale for the move.  As I often explain, sometimes currency markets are simply perverse.
 
There is no US data due this morning, but we do hear from two more Fed speakers, Williams and Bostic. However, both have already spoken this week and there certainly hasn’t been any data that would likely have changed their views.  It seems all eyes will be on the equity markets this morning.  If they follow yesterday’s moves lower, I think we may see a more traditional risk-off outcome, but even if stocks rebound, it is hard to get too negative on the greenback.
 
Good luck and good weekend
Adf
 
 
 
 
 
 
 

Things Went to Hell

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There once was a company, strong
Whose shares, everyone had gone long
But things went to hell
Nvidia fell
And folks wonder now, were they wrong?
 
The narrative hasn’t adjusted
Though certainly some are disgusted
AI, after all
To which they’re in thrall
Is perfect, so why’s it seem busted?

 

Times are tough for macro pundits and analysts, like this poet, as there is so little ongoing at the moment.  Data releases are sparse, and generally of a secondary nature and even commentary has been less active.  Truly, the summer doldrums have arrived.

With this in mind, perhaps it is a good time to consider what the broad risk asset narrative looks like these days, especially since the most recent version was exceedingly clear; Nvidia is the only company that matters in the world and its stock price should go to 10,000.  While there had been pushback on this idea, with the naysayers comparing the stock to Cisco and Qualcomm during the dot com bubble in 2000, the true believers countered with the fact that Nvidia was wildly profitable and given the race by companies all over the world to embrace AI, would continue to grow at its extraordinary recent pace.  But consider…

Back in the 1970’s, there was a group of companies described as the Nifty Fifty that represented the growth companies of the time.  And they were great companies, with most of them still around today including American Express, Coca-Cola, IBM and Walt Disney, to name just a few.  The thesis at the time was that these companies represented the future, and that if an investor didn’t own them, they were missing out.  The thing that was ignored at the time (and in truth is ignored in every bubble) is there is a difference between the company and its share price.  Overpaying for a good company can result in poor investment performance even if the underlying company continues to have magnificent results.

I mention this era as there are certainly parallels to the current mania for the Supremes (Nvidia, Apple, Microsoft) and the narrative at that time.  There is nothing inconsistent with understanding that these companies, and especially Nvidia, have created something special, but that they cannot possibly sustain their current valuations and so their share prices may fall.  And they can fall a lot.  After all, Nvidia has retraced 13% in just 3 sessions.  As much momentum as these shares have had on the way up, they can have that much and more on the way back down.  I’m not saying this is what is going to happen today, simply highlighting that trees don’t grow to the sky.  Perhaps we have now seen how tall they can grow.  

One thing I sense is that if this correction continues, it is likely to broaden out.  Perceptions are funny things, and if the zeitgeist changes, even if the companies continue to put up terrific numbers, the share prices can go a lot lower.  Consider that if the Supremes each fall 50%, they will still have market caps of $1.5 trillion and be amongst the largest companies in the world.  In fact, if they fall 50%, I’m pretty confident so would most of the rest of the market, so they would likely maintain their relative crowns of size, just at a smaller number. 

At any rate, this is an important discussion as the equity markets have been key drivers of all markets, and a change there will naturally result in some different opinions elsewhere.  Arguably, the biggest question is, if the stock market falls sharply, but the economic data don’t respond in the same way, will the Fed really cut rates?  There are many who remain firmly in the camp that the ‘Fed put’ is still intact, and they will come to the rescue.  Personally, my take is if there is a Fed put, the strike price is a lot lower, maybe S&P 3500, not S&P 5000.  Chairman Powell has enough other problems to address so that the value of the S&P is probably not job one.  In fact, it could become quite a political problem for him if the Fed is seen as rescuing Wall Street again while so many on Main Street struggle.

Ok, it’s time to look at the freshly painted wall and watch it dry overnight session.  Yesterday’s US session was unusual for its composition as the DJIA had a solid day, gaining 0.7%, while the NASDAQ suffered, falling -1.0%.  Asia, too, had an interesting session with the Nikkei (+1.0%) and Australia (+1.3%) both rallying while the Hang Seng was little changed and China (-0.5%) fell.  One possible explanation is that the tech sectors are getting unwound while money flows into less exciting areas like natural resources and manufacturing.  Of course, given there are no tech shares of which to speak in Europe, the fact that every bourse on the continent, and the UK as well, is lower, led by the DAX’s -1.0% decline, I am searching for another explanation.  At this hour (7:20) US futures are a touch firmer, 0.3%, but I don’t put much stock in this given the past several sessions.

In concert with the risk-off theme, bond markets are seeing a bid with corresponding yield declines.  Treasury yields are lower by 1bp with European sovereigns lower by between -2bps and -4bps.  There is still a great deal of anxiety, at least according to the press, about the French elections, but given the political bias of most mainstream media, which is decidedly against the idea that Marine Le Pen’s RN should win, it is possible that the actual situation is far less concerning.  The fact that the Bund-OAT spread continues to narrow at the margins tells me that there are fewer concerns than immediately following Macron’s call for the snap election.

Oil prices (-0.6%) are retracing yesterday’s modest gains as there continues to be uncertainty over the demand situation and whether economic activity is slowing offset by what appears to be a modest escalation in the Russia/Ukraine war with concerns that could impact supply.  As to the metals markets, prices there are little changed this morning after having edged higher yesterday.  My take here is that traders are keenly focused on Friday’s PCE data as an indication to whether the Fed will be cutting sooner rather than later.  The sooner the cut, the better metals prices should perform.

Finally, the dollar is almost unchanged this morning after having fallen modestly yesterday.  All eyes continue to focus on USDJPY, although it has slipped back this morning to 159.50.  Right now, my sense is there are many ‘tourists’ in the FX market trying to play for the next intervention, but as I said yesterday, I do not believe the MOF is going to be as concerned as they were in April/May given the pace of the move has been so much more modest.  For instance, last night FinMin Suzuki explained, “[the MOF] will continue to respond appropriately to excessive FX moves.  It is desirable for FX to move stably.”  Now, aside from the oxymoron of stable movement, this type of commentary is typically not indicative of any immediate concerns.  As to the rest of the G10, modest gains and losses define the day although we have seen both MXN (-0.65%) and ZAR (-0.4%) slide this morning, although given the amount of money involved in the carry trade for both these currencies, this is likely just positions adjusting rather than a fundamental change.

This morning brings more tertiary data with the Chicago Fed National Activity Index (exp -0.4), Case Shiller Home Prices (6.9%) and Consumer Confidence (100).  We also hear from two speakers, Governors Cook and Bowman.  Perhaps the most interesting thing yesterday was that SF Fed President Daly specifically touched on Unemployment in her comments, explaining that though there was still insufficient confidence that inflation was declining to target, she was paying close attention to the Unemployment rate, “so far, the labor market has adjusted slowly, and the unemployment rate has only edged up. But we are getting nearer to a point where that benign outcome could be less likely.”  I have a feeling that the employment report a week from Friday is going to have a lot more riding on it than in the recent past.  Any weakness there could really change the tone of the market regarding the economy and the Fed’s actions.

It is difficult to get too excited about today although if the recent correction in Nvidia continues and widens to some other names (a distinct possibility) do not be surprised if there are some fireworks later on.  In that case, I would look for a traditional risk-off session with the dollar higher while bond yields and stocks fall.

Good luck

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