Tag Archives: #riskoff

Not Well Understood

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The ISM data was weak
And traders, more bonds, did soon seek
The oil price fell
The dollar, as well
But stocks ended close to their peak
 
So, is now bad news really good?
‘Cause Jay will cut rates, or he should
Or is it the case
That growth’s slowing pace
Means risk is not well understood

 

The narrative had a little hiccup yesterday as the ISM data was released far weaker than expected.  The headline number, 48.7, fell vs. last month and was a full point below market expectations.  The real problem was that while the Employment sub-index was solid, New Orders tanked, and Prices remained high.  If you add this to the Chicago PMI data from Friday, which at 35.4, was the lowest print since the pandemic in May 2020 and back at levels seen in the recessions of 2001 and 2008, it is fair to question just how strong the US economy is right now.

Adding to this gloom is the news that the Atlanta Fed’s GDPNow estimate slipped to 1.8% for Q2, down from 2.7% last Friday, and the trend, as per the below chart, is not very pretty.

Given the data, it can be no surprise that the Treasury market rallied sharply, with yields declining 8 basis points on the session, although they are little changed this morning.  After all, if the economy is slowing, the theory is that inflationary pressures will decline, and the Fed will be able to cut rates sooner rather than later.   And maybe that is true.  But when we last heard from the FOMC membership, most were pretty convinced they needed to see more proof that inflation was actually lower, rather than simply that slowing growth should help their cause.  And I might argue that a weak ISM print, especially with the prices portion remaining high, is hardly the proof they require.

But yesterday’s markets were a bit confusing overall.  While the initial response to the weak data led to immediate selling across all equity markets, by the end of the day, those losses were reversed such that the NASDAQ had a fine day, rising 0.5%.  Ask yourself the question, why would stocks rebound despite further evidence that the economy is slowing down.  The obvious answer is that a slower economy will lead to slowing inflation and allow the Fed to reduce interest rates before long.  Of course, the flip side of that story is that a slower economy implies companies will lose pricing power as demand slides, thus reducing available profit margins and overall profits.  It seems hard to believe that stock prices will rally amid declining earnings, although these days, anything is possible.

While the Fed’s quiet period has many advantages (in truth I wish the entire time between meetings was the quiet period) one of its key attributes is that the narrative can run wild in whatever direction it likes.  As we will be receiving quite a bit of data this week, I suspect the narrative will have a few more twists and turns yet to come, although there is no question that the bulls remain in control of the conversation.  

One other thing to keep in mind about that ISM data is that while the US data was weak, the PMI data elsewhere in the world indicated that the worst had been seen elsewhere.  While it is not full speed ahead yet in Europe or the UK or China, the trend is far better than in the US.  Remember, a key part of the narrative is that the US is the ‘cleanest shirt in the dirty laundry’ and so funds continue to flow into US equities and the dollar by extension supporting both.  But what if other nations are starting to see an uptick in their growth stories while the US is starting to slide a bit?  Perhaps the non-stop bullishness for the NASDAQ will find a limit after all.  Perhaps another way to consider this is to look at the Citi Economic Surprise Index, which is designed to compare actual data releases with the forecasts before the release.  As such, a high number shows better than expected data and vice versa.  As you can see from the below chart, the trend here is lower.

Source: macrovar.com

One interesting aspect of this chart is that you can see during Q1, when the equity markets rallied and bullishness was rife, this index was rallying as well.  But remember what we learned last week regarding Q1’s GDP, it was revised lower to just 1.3% annualized.  So, if better than expected data still led to weak growth, what will declining data do?  

In the end, at least in my view, the economy is struggling overall, although not collapsing.  If I am correct, then it leads to several potential, if not likely, outcomes.  While the Fed has continuously claimed they remain focused on inflation, if growth starts to decline more sharply, and unemployment starts to rise more rapidly, they will cut rates regardless of CPI or PCE, and they may well end QT if not start QE again.  The clear loser here will be the dollar.  Equity markets are likely to initially react to the rate cuts and rise, but if earnings suffer, I think that will reverse.  Bond markets, too, will rally initially, but if inflation rebounds, which seems highly likely if the Fed eases policy, I don’t think the long end of the yield curve will be very happy, and we could easily see 5.0% or higher in 10-year yields.  Finally, commodities will see a lot of love and rally across the board.

Ok, let’s look at what happened overnight, as other markets responded to the surprisingly weak US data.  Asia wound up mixed, similar to the US indices, as Japan (-0.25%) slipped while China (+0.75%) rallied along with Hong Kong (+0.25%).  But the big mover overnight was India (-5.75
%) which fell sharply as the election results there indicated that PM Narendra Modi, while winning a third term, saw a decline in his support that left him somewhat weakened.  The rupee (-0.5%) also slipped, although nothing like what we saw yesterday in Mexico.  As to the rest of the region, we saw winners (Indonesia, Malaysia) and laggards (Taiwan, Korea, Australia) so no real trend.  In Europe, this morning, there is a trend, and it is all red, with losses ranging from -0.4% in the UK to -1.1% in Spain.  The only data here was employment in both Spain and Germany, and while both numbers were a touch soft, neither seemed dramatic.  And, as I type (8:00), US futures are all lower by -0.3%.

In the bond markets, yesterday’s Treasury rally was mimicked by European sovereigns, with yields there falling as well, albeit not quite as much as in the US.  This morning, the European market is extremely quiet, with yields +/-1bp from yesterday’s closes.  However, overnight, we did see Asian government bond yields fall, with JGB’s -3bps and greater declines elsewhere in the space.

Oil prices (-1.85%) are under severe pressure this morning, following on yesterday’s $3/bbl decline, falling another $1.50/bbl.  It seems the combination of the weak ISM data and the OPEC+ discussion of an eventual return of more production to market next year was enough to convince a lot of long positioning to throw in the towel.  As is its wont, the oil market can move very sharply and overshoot in either direction.  It feels to me this could be one of those cases.  But commodity prices are getting killed everywhere this morning as although metals held up well yesterday, this morning we are seeing blood in the water.  Both precious (Au -0.9%, AG -3.4% and back below $30/oz) and industrial (Cu -2.3%, Al -0.5%) are falling as slowing growth and the belief that it will reduce inflationary pressures is today’s story.

Finally, the dollar, which sold off sharply yesterday in the wake of the ISM data, is bouncing a bit this morning, at least against most of its counterparts.  While most of the G10 is softer, led by NOK (-1.2%), the outlier is JPY (+0.85%) which is suddenly behaving like a safe haven amid troubled times.  I think that the increased uncertainty amid Japanese investors as to the state of the global economy may have them bringing home their funds, especially now that 10yr JGB yields are above 1.0% with no hedging costs.  As to the EMG bloc, MXN (-1.7%) remains under severe pressure but today they are not alone with all EEMEA currencies and other LATAM currencies declining as well.

The two data points this morning are the JOLTS Jobs Openings (exp 8.34M) and Factory Orders (0.6%), both released at 10:00.  Obviously, there is no Fedspeak, so I expect that equities will be the driver, and if fear starts to grow, we could get an old-fashioned risk off day with stocks falling, bonds rallying and the dollar gaining as well.

Good luck

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The Ocular Veil

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In NY, the jury has spoken
And folks who run risk have awoken
Now looking ahead
Investors may dread
That property rights have been broken
 
For markets, what this may entail
Is loss of the ocular veil
The full faith and credit
Of Treasury debit
Just might not be seen as so hale

 

If you have suffered through my daily writings long enough, at least past the poetry up front, you have probably surmised that my views are in accord with free markets and capitalism.  In addition, regardless of the political insanity that continues to top headlines in every publication in the US, and across much of the world, I only try to touch on it if I believe it is going to have an impact on market behavior, whether short or long term.  For instance, during the runup to Brexit, I focused on the issue because I felt certain the outcome would impact the value of the pound as well as UK interest rates and equity markets.

Well, I might argue that another Rubicon has been crossed in the US, and one that I fear may have negative long-term implications for US assets of all stripes.  The guilty verdicts that were announced yesterday afternoon against former President Donald Trump are a new, and very disturbing outcome.  Whatever your view of the man, and whether you would like to see him be re-elected or not, the idea that a sitting government in the US would throw all its effort into imprisoning its major opponent seems far more akin to the actions of dictators like Vladimir Putin, Nicolas Maduro and Xi Jinping.  And yet here we are today with that being the biggest story in the world.

What, you may ask, is the market angle here?  Consider the other thing that has happened during this administration with respect to the Russian central bank’s reserve assets at the time of Russia’s invasion of Ukraine in the winter of 2022.  While freezing them was the first step, recent comments by Treasury secretary Yellen and her compatriots in the G7 indicate that they are going to start to confiscate those assets and give them to Ukraine to help them fight the war against Russia.  Irony aside, the bigger picture, which has been discussed numerous times since the initial action, is that the move calls into question the safety of foreign government assets held in the US and other G7 nations, especially those held in the most liquid, and ostensibly safest, debt instruments in the world, US Treasury securities.  If other nations begin to worry that the full faith and credit concept has a political angle, rather than purely a financial one, it will change asset allocations all over the world.

We have seen this already as China and Russia have been transacting between themselves in CNY, and we have seen India seek to pay Russia in rupees for the oil they have been buying.  Saudi Arabia has also been willing to accept CNY for oil sales in a major change to agreements made back in the 1970’s between the US and the Kingdom.  Of course, this has been the genesis of all the talk of the end of the dollar and dollar hegemony, and the idea that an alternative reserve currency will soon be coming to fruition.

Let me give you my take, at least at this early stage.  The connection between the Trump verdict and the Russian reserves is that arguably the bedrock of the US economy and one of the fundamental keys to its long-term success has been the knowledge, by friend and foe alike, that the rule of law is deeply imbedded into all business dealings here.  We know that other nations can be capricious and confiscate foreign-owned assets, or stomp on domestic businesses for political reasons.  But in the US, historically, while politics was part of the economic process, that strand was never before in doubt.  I fear that has changed irreparably now with the Trump verdict in combination with the Russian reserve assets decisions.

Going forward, will foreign investors truly believe that the rule of law, as written in the Constitution protecting property rights, is sacrosanct?  And if that is not the case, or there is doubt that is the case, will foreign investors (and domestic ones for that matter) be as anxious to purchase and hold US assets, whether they are equities or debt?  It is way too early to answer that question, but the fact that it needs to be asked is an entirely new and disconcerting situation.

I know this may seem like a big assertion based on limited evidence.  This will especially be true if you are of the belief that Trump is a crook, the NY DA was exactly correct, and the trial outcome was appropriate.  However, I am confident that this outcome will be seen very differently than that by many citizens and investors around the world and that very question of property rights and the rule of law will be raised again and again.  And that cannot be good for US risk assets.

If we add this new political angle to what has been a recent spate of weaker than expected economic data, it is quite possible, and I believe we are already moving in this direction, that soon, “bad news will be bad”.  This means that weak economic data will not encourage the bulls to buy quickly on the thesis that the Fed is going to start cutting rates sooner than the current view, but rather that a weak economy with still sticky inflation means that company earnings are going to suffer greatly, and equity multiples will rerate lower to reflect that.  Not necessarily today or Monday, but over time.  I am going to go out on a limb and predict that the highs for US equities are now in.  So, S&P 500 at 5341, DJIA at 40,077 and NASDAQ 100 at 17,032 are all we are going to get in this move with a substantial correction far more likely than a rally extension.  I also believe that the dollar will start to suffer more aggressively going forward, that the Treasury market will suffer as well, so much so that the Fed is going to be buying bonds again before the year ends, and that commodities are going to trade much higher.

Back in January, my view was just this, that we would peak around mid-year, that the Fed might get one rate cut in, but that was all, and that risk assets would finish the year much lower.  That was based on a belief that the economy would roll over.  Now, clearly the economy, while softening a bit, is not showing signs of a significant downturn.  After all, given how much money the government is pumping into it, it would be difficult to wind up with nominal GDP falling much at all.  But this is an entirely different reason, and one that is far more worrisome in my eyes, and likely to be more gradual in its impact, but more long-lasting.  As I said, a Rubicon has been crossed and not in a good way!

My apologies for that rant, but I am truly concerned for the way that things play out going forward.  However, let’s turn to the financial and economic issues rather than the political now.  US equities were under pressure all day yesterday, closing lower across the board as concerns over a lack of Fed policy ease joined with additional weaker-than-expected US data.  While the GDP revision was exactly as expected, Final Sales and Real Consumer Spending were both softer than forecast, and in the end, those are the critical drivers of economic activity.  The Trump verdict was released after the market close, so had no direct impact.  But following the US session, Asian stocks went their own way.  The Nikkei (+1.1%) performed well despite (because?) Tokyo CPI -ex food & energy printed at 2.2%, higher than last month, but continuing its broad downtrend from early last year.  Australia and New Zealand also performed quite well, but the rest of the region had a tougher time with both Hong Kong (-0.8%) and Mainland (-0.4%) shares under pressure and losses almost everywhere else in Asia.  

In Europe, the picture is one of mostly very small declines with the UK (+0.3%) the outlier in response to some solid UK housing data as well as growth in Mortgage Lending.  As to US futures, at this hour (6:00) they are little changed as we all await the PCE data.

In the bond markets, yesterday’s decline in yields is being reversed this morning as Treasuries creep back higher by 1bp while European sovereigns are seeing more selling pressure after Eurozone CPI was released at a hotter than forecast 2.6% (2.9% core).  While all the ECB commentary is still focused on a cut next week, this cannot have been a welcome result for the doves there.

Turning to the commodity markets, oil is slightly lower this morning following yesterday’s decline that was based on the significant build in gasoline inventories.  This was quite the surprise given the start of the summer driving season and may reflect softer overall demand (remember the weak GDP data).  As to the metals markets, gold, after a modest bounce yesterday is unchanged while silver (+0.25%) and copper (-0.5%) are responding differently to yesterday’s declines and weak data.  However, as I indicated earlier, I foresee these seeing continued structural strength.

Finally, the dollar fell yesterday on the back of softer US yields, at least versus the G10 currencies.  As I highlighted yesterday, several EMG currencies are also under pressure and we continue to see that this morning, notably KRW (-0.7%) which cannot get out of its own way as worries over Chinese growth (last night Chinese PMI data was weak across the board with Manufacturing printing at 49.5) continue to weigh on its export prospects.  But I would say that broadly, the dollar is on its back foot right now and unless US yields start to climb again, will remain so.

This morning’s key data is, of course, PCE (exp 0.3% M/M for both Headline and Core with 2.7% and 2.8% expectations for the Y/Y respectively.)  As well we see Personal Income (0.3%), Personal Spending (0.3%) and Chicago PMI (41.0).  Finally, the last Fed speaker before the quiet period will be Raphael Bostic from the Atlanta Fed, whom we have heard half a dozen times in the past two weeks and seems unlikely to change his tune.  However, I must note that there is some dissent on the FOMC as evidenced by dueling comments yesterday from Dallas’s Lorie Logan and NY’s Jonathan Williams.  Logan continues to be concerned over the pace of decline in inflation and exhorts the committee to remain flexible and consider hikes if necessary.  Williams was adamant that inflation would achieve their target by next year and easing policy was appropriate.  In truth, that has been the most dovish commentary we have heard from a Fed speaker in a while.

One last thing regarding elections.  Yesterday’s South African results show that the ANC, which has led the country since Apartheid, is now scrambling to put together a coalition government which will be much weaker, or at least less able, when it comes to implementing any agenda.  Meanwhile, this weekend, Mexico goes to the polls and AMLO’s hand-chosen successor, Claudia Sheinbaum, seems set to win in a landslide with very little change in the nation’s international stance.

As I said at the top, the changes I foresee will be gradual, but I believe the direction of travel has changed.  Today will be a response to the PCE data, where a hot number is very likely to see concerns rise over the Fed’s future actions and risky assets decline, while a cooler than forecast number could well see a short-term rally.  But do not lose sight of the big picture.

Good luck and good weekend 

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Worries Abound

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That smell in the market is fear
In truth, for the first time this year
As both bonds and stocks
Are now on the rocks
And no sign t’will soon disappear
 
The Fed is remaining on hold
Though elsewhere, rate cuts are foretold
But worries abound
As risk is unwound
That everything soon will be sold

 

It is very difficult to get excited about much in the markets these days as we see stocks, bonds and commodities all slide in price.  The fear in markets is palpable as investors and traders clearly remember 2022, when both stocks and bonds fell sharply and those holding the traditional 60/40 portfolio got crushed.  This is not to say that we are seeing the same thing right now, but the very fact that we can have both asset classes suffer simultaneously, even for a few days, is disconcerting to everyone.

It is difficult to pin down a specific driving force right now as opposed to the 2022 scenario when the Fed was raising the Fed funds rate aggressively amid a serious bout of inflation.  But currently, there are a relatively equal number of pundits and analysts on both sides of the inflation and growth debate.  With this as the case, it doesn’t seem logical that there would be a significant trend shift.

So, this morning let’s try to consider the current stories that may be driving this recent bout of investor skepticism.  On the macro side of things, while recent data hasn’t been awful, it has hardly been scintillating.  For instance, the recent Dallas Fed Manufacturing Index was quite weak, similar to what we saw with Philly and Empire State, but the Richmond number rebounded.  While we all await this morning’s second look at Q1 GDP (exp 1.3%, down from the initial reading of 1.6%), there is much more focus on tomorrow’s PCE data.  In fact, given the dour mood in the market, it is hard to remember that the CPI data earlier this month was seen as a slight positive.  

But bigger problems reside in the Retail Sales and consumption story on the micro side of things as we have been hearing from an increasing number of companies that customers are balking at higher prices.  Retail Sales were flat in April, hardly a sign of strength, and just this morning we had Walgreens say they will be cutting prices on 1500 items in their stores in an effort to stimulate sales.  We heard bad tidings from Target earlier this month, as well as McDonalds, Starbucks and Walmart.  

It is certainly difficult to hear these reports and come away feeling bullish about either the economy or the equity markets.  Yesterday’s Fed Beige Book was its usual mix of some good and some bad, but no strong trend in either direction.  Atlanta Fed president Bostic explained yesterday that “My outlook is that if things go according to what I expect — inflation goes slowly, the labor market slowly and orderly moves back into a sort of a weaker stance, but a stable-growth stance — I’m looking at the end of the year, the fourth quarter, as the time where we might actually think about and be prepared to reduce rates.”  That sounds like a December cut, a far cry from expectations just last week, let alone the beginning of the year.

In fact, I challenge you to come up with a bullish piece of news that may drive sentiment back toward overall risk bullishness.  Arguably, the only thing around is Nvidia, which is pretty thin gruel on which to sustain a global economy!  And ask yourself, how much of that is overdone?

Looking elsewhere in the world doesn’t make you feel much better either.  For instance, in Europe, while a rate cut next week seems certain, this morning’s Unemployment release showing a decline to 6.4%, the lowest level ever recorded, is hardly cause for the ECB to get aggressive in cutting rates further.  Similarly to the US, with unemployment so low, and inflation remaining well above target, please explain why any central bank would feel compelled to cut rates.

Summing up, it is quite easy to make the case that risk assets have gotten far ahead of themselves on the hope that the global interest rate structure was going to decline thus allowing the leverage that had been implemented during the post-Covid ZIRP and NIRP regimes to be refinanced at more attractive levels.  However, as the data continues to show more resilience than expected in both the employment and inflation regimes, central banks find themselves with few good reasons to cut rates despite their very clear bias to do so.  And now that each move and utterance they make is scrutinized so closely, they have limited incentive to act.  Here’s my take; while we may see some initial rate cuts by the ECB, BOE and BOC, do not look for a long cycle absent a significant decline in inflation or sharp rise in unemployment, neither of which seems imminent.

Ok, the negativity in the US yesterday followed through to Asia with all markets lower there, some by a bunch like the Nikkei (-1.3%) and the Hang Seng (-1.3%) while others were merely down by -0.5% or so.  However, in Europe this morning, bourses have edged a bit higher with one outlier, Spain’s IBEX (+1.25%) the biggest beneficiary after inflation numbers from that nation proved cooler than expected.  Alas, at this hour (7:30) US futures are lower by -0.5% or so after a weak Salesforce earnings report last night.

In the bond market, the last two days of higher yields has halted for now with Treasury yields lower by 2bps and European sovereigns trading in a similar manner.  Yesterday’s 7-year Treasury auction was also soft, although the bid-to-cover ratio was 2.37, not as low as the 5-year the day before.  However, confidence in the ability of the market to continue to absorb the number of Treasuries required to fund the government deficit appears to be slipping, at least a little.

In the commodity markets, oil is unchanged this morning, consolidating its recent gains as traders await the latest OPEC news from a meeting scheduled for next week.  In the metals markets, gold is also little changed this morning but both silver and copper are under pressure as they continue to give back some of their recent substantial gains.  For instance, even after today’s -2.2% performance in silver, it is higher by 4% in the past week and 17% in the past month.  

Finally, the dollar is under some pressure this morning following several days of strength on the back of the higher US yield story.  The biggest G10 movers are CHF (+0.7%) and JPY (+0.6%) as the former responds to comments from the SNB hinting that further rate cuts may be delayed over concerns of the franc weakening too quickly, while the latter looks mostly like a trading response as there were no comments or data to drive things. After all, despite the threat of intervention, the yen has been sliding consistently of late.  In the EMG bloc, it is a different story as the only noteworthy gainer is CNY (+0.25%) while ZAR (-0.7%) on the back of uncertainty regarding the election outcome, and KRW (-0.5%) on the back of continued weakness in the KOSPI index, cannot find any support today.

On the data front, in addition to the GDP data mentioned above, we see the weekly Initial (exp 218K) and Continuing (1800K) Claims as well as the Goods Trade Balance (-$91.8B).  Alongside the GDP data are a series of other indices like Final Sales (2.0%) and Real Consumer Spending (2.5%) which are important numbers to get a more holistic view of the economy.  Of course, it wouldn’t be a day ending in “Y” if we didn’t have more Fed speakers, with two more on the docket, Williams and Logan.

It is tough to fight a sentiment that is turning negative.  While I would expect the dollar to benefit from this, right now it is a mixed picture.  I doubt either Fed speaker will break new ground, so I fear that the overall negativity is going to be today’s key theme.  Lower stocks, lower bonds and a mixed dollar like we’ve seen overnight seem likely to be what we see in the US.

Good luck

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Losing Some Steam

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While equity bulls all still dream
The Fed has a rate cutting scheme
All ready to go
That going’s been slow
And clearly is losing some steam
 
Kashkari’s the latest to say
That higher for longer will stay
The policy choice
Of every Fed voice
Thus, bonds had a terrible day

 

Arguably, the most impactful news from yesterday’s session was the fact that the Treasury auctions of 2-year and 5-year Notes was so poorly received.  The tails on both auctions were more than 1 basis point, which for short-dated paper is highly unusual.  As well, the bid-to-cover ratio for the 5-year was just 2.3, well below the longer-term average of 2.45 resulting in dealers taking down more of the auction than either expected or wanted.  The overall bond market response was to see 10-year yields rise 7bps, although the 2-year yields only edged higher by about 2bps, thus steepening the yield curve a bit.

Of course, the question at hand is, what happened?  Not surprisingly, there are as many answers to this question as people asked, but a few of the logical responses ranged from the short-term concept that recent data has shown more robust growth than anticipated thus reducing the chance of any rate cuts soon to the long-term view that the Treasury is issuing so much debt they have overwhelmed the market and buyers are reluctant to step in at current levels given the ongoing deficit spending and lack of prospects for that to end regardless of the election results in November.

Of course, there may have been a more direct answer after Minneapolis Fed president Kashkari, added some quite hawkish commentary from an event in London.  Comments like, “I don’t think anybody has totally taken rate increases off the table.  I think the odds of us raising rates are quite low, but I don’t want to take anything off the table,” got tongues wagging, as well as, “Wage growth is still quite robust relative to ultimately what we think would be consistent with the 2% inflation target,” and “I want to get all the data I can get before the next FOMC meeting before I reach any conclusions, but I can tell you this, it certainly won’t be more than two cuts.”  This certainly didn’t warm the cockles of bond bulls’ hearts.  Stock bulls either, as other than Nvidia, equity markets gave up early gains after the comments.

Whatever the specific driver(s), the end result was that bonds sold off, and both stocks and metals markets gave up early gains.  In fact, the only beneficiaries on the day were the dollar, on the back of those higher interest rates and less prospects for future cuts, and oil, which continues to benefit from re-escalating tensions in Gaza and expectations that OPEC+ will continue producing at its current reduced rates.  

However, in truth, market activity remains lackluster overall.  The funny thing is that despite most risk asset markets still hovering near all-time highs, the mood has become far dourer than you might expect.  My take on reading headlines as well as my X(nee Twitter) feed is that there is much less bullishness around than just a week or two ago.  Certainly, the FOMC Minutes released last week didn’t help sentiment, but in fairness, the Fed commentary has been consistent since the last meeting, higher for longer has been the default option for every speaker.  So, let us look elsewhere for the catalysts.

Overnight, the Australian inflation rate rose to 3.6% unexpectedly with the result that traders have increased the odds of a rate hike Down Under although the Aussie dollar did not benefit at all, actually falling -0.25%. The bulls’ basic problem is that inflation throughout the Western economies is simply not cooperating with respect to heading back to central bank targets, and the prospect of rate cuts is slipping away.  In fact, in Japan, a BOJ member, Seiji Adachi, even indicated that the BOJ may be forced to act if the yen continues to weaken, even though he is not confident that the inflation rate is going to be sustainably at 2.0% anytime soon.  The point is, central banks, which had been almost universally expected to cut rates aggressively this year based on the idea that inflation was receding, are beginning to abandon those views and have continued to put rate hikes back in play, at least verbally.  While markets have not really started pricing hikes in yet, the number of rate cuts expected has fallen dramatically.  Keep in mind that if the future has higher rates in store, it seems likely that many risk assets will struggle.

Ok, let’s review last night’s price action to flesh out this bearishness.  In Asia, Japanese (Nikkei -0.8%) and Hong Kong (-1.8%) stocks were under pressure alongside Australian (-1.3%), Korean (-1.7%), Indian (-0.9%) and Taiwanese (-0.9%) shares.  In fact, the only market that managed to hold its own was China’s CSI 300 (+0.1%) after the IMF upgraded their GDP forecast to 5.0% for 2024. Not surprisingly given the overall tone, European bourses are all lower as well, ranging from -0.25% in the UK to -1.0% in Paris.  The most relevant data seems to be German inflation with the States reporting slightly higher than last month although the national number isn’t released for a little while yet.  Meanwhile, at this hour (7:30) US futures are in the red by about -0.6% across the board.

In the bond market, yesterday’s rally in yields is continuing with Treasuries higher by another 2bps and European sovereign yields all higher by between 4bps and 7bps.  Even JGB yields rose 5bps overnight to new highs but the biggest move was seen in Australia at +14bps after that inflation data.  While the future remains uncertain, I still don’t see any evidence that inflation is ebbing further and so there is no reason for bond yields to decline sharply.

In the commodity markets this morning, as mentioned above, oil (+0.1%) continues to edge higher while metals (Au -0.7%, Ag -0.35%, Cu -1.3%) are under pressure with higher interest rates all around the world.  But in fairness, these metals are all still solidly within their recent upward trends, so this seems like consolidation rather than a change in theme.

Finally, the dollar continues to benefit from the higher yield story in the US with gains this morning tacking onto yesterday’s moves.  While none of the moves have been very large, the movement has been universal, with only the yen, which is unchanged on the day, holding its own.  Aside from the interest rate story we also have South African elections today where the ANC, which has led the government since the end of Apartheid, appears set to lose its majority as Unemployment and Inflation rage there and the rand (-0.3%, today, -1.7% in the past week) is suffering accordingly.  Otherwise, there are precious few new stories to note here.

On the data front, the most noteworthy release is the Fed Beige Book this afternoon and we also hear from two more Fed speakers, Williams and Bostic, although it would be shocking if they didn’t repeat the higher for longer mantra.

Summing it all up, the recent Fed speakers seem to be leaning even more hawkish than the Minutes seemed to be, US yields continue to shake off every effort to sell them as the data has held in well enough to prevent any major fears of a sharp decline in the economy and quite frankly it is very difficult to look at the current situation and conclude that the US economy is in any trouble or that the dollar is going to suffer.  Can equities fell some pain?  Certainly, that is possible, but it is hard to see investors fleeing to bonds in that situation.

Good luck

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Not Soaring

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It seems that prices
In Japan are not soaring
Like the hawks would want

 

Japanese inflation data last night showed a continued decline as the Core rate fell to 2.2%, and the so-called super core rate slipped to 2.4%, its lowest level since October 2022.  As you can see in the super core chart below, the trend seems clearly to be downward although the current level remains far above inflation rates for most of the past 30 years.

Source: tradingeconomics.com

The irony here is that were this the chart of the inflation rate in any other G7 nation, the central bank would be crowing about how successful they had been at slaying the inflation dragon.  Alas, as the chart demonstrates, Japan’s dragon was a different species, and one that I’m pretty sure the 122 odd million people there were very comfortable having as a “pet”.  After all, I have never met a consumer who was seeking prices to rise before they bought something, have you?

From a market perspective, the continued decline in inflation rates calls into question just how much further Japanese interest rates need to rise in order to achieve the BOJ’s goals.  Again, remember the BOJ’s goals for the past decade has been to RAISE the inflation rate to 2% and their tactic has been to create the largest QE program in the world such that they now own more than 50% of the outstanding Japanese government debt across all maturities.  If inflation continues to decline back to, and below, 2%, while I’m confident the general population there will have no objections, Ueda-san may find himself in a difficult position.  

Arguably, if higher inflation is the goal (and politically that seems nuts) then the most effective tool the nation has is to allow the yen to continue to weaken and import inflation.  I continue to believe that this will be the process going forward, and while very sharp and quick declines will be addressed, a slow erosion will be just fine.  Absent a major change in US monetary policy to something much easier, I still don’t see a case for a much stronger yen.  However, as a hedger, I would continue to consider options to manage the risk of any further bouts of intervention.

While many are still of the view
That rate cuts are long overdue
What yesterday showed
Is growth hasn’t slowed
So, Jay and his friends won’t come through

Back home in the US, yesterday’s data releases did nothing to encourage the large contingent of people who are desperate looking for a rate cut before too long.  While New Home Sales were certainly lousy, falling from the previous month’s downwardly revised level, and the Chicago Fed’s National Activity Index was also quite soft, indicating economic activity had slowed last month, the Flash PMI data got all the attention with both Manufacturing (50.9) and Services (54.8) rising sharply, an indicator that there is still life in the economy yet.  The result was that we saw US yields rise (10yr +7bps), the dollar strengthen, and equity markets give back their early, Nvidia inspired, gains to close lower on the day.  While equity futures are rebounding slightly this morning, confidence that a rate cut is coming soon has clearly been shaken.

Adding to the gloom was a reiteration by Atlanta Fed president Bostic that it is going to take a lot longer for rates to impact inflation than in the past.  In a discussion with Stanford Business School students, he focused on the fact that so many people locked in low mortgage rates during the pandemic and recognized, “the sensitivity to our policy rate — the constraint and the degree of constraint that we’re going to put on is going to be a lot less.” For those reasons, Bostic said, “I would expect this to last a lot longer than you might expect.”  This discussion has been gaining more adherents as the punditry is grudgingly beginning to understand that their previous models are not necessarily relevant given all the changes the pandemic wrought.  Summing up, there continues to be no indication, especially in the wake of the more hawkish tone of the Minutes on Wednesday, that the Fed is going to cut rates soon.

So, with the new slightly less perfect world now coming into view, let’s take a look at market behavior overnight.  Yesterday’s US equity slide was continued everywhere else around the globe with Asian markets (Nikkei -1.2%, Hang Seng -1.4%, CSI 300 -1.1%) under uniform pressure and European bourses, this morning, also in the red, but by a lesser -0.4% or so across the board.  For many of these markets (China excepted) they have recently run to all-time highs, or at least very long-term highs, so it should be no surprise that there is some consolidation.  There is a G7 FinMin meeting this weekend and the comments we have heard so far indicate that the ECB is on track to cut rates next month, but there are no promises for further cuts.  Net, it seems clear that as much as most central banks want to cut interest rates, they are still terrified that inflation will return and then they have an even bigger problem.

In the bond market, it has been a very quiet session after yesterday’s yield rally with Treasury yields unchanged this morning and European sovereign yields similarly unmoved.  Even JGB yields are flat on the day as it appears bond traders and investors started their long weekend a day early.  Remember, not only Is Monday a US holiday, but it is a UK holiday as well, so there will be very little activity then.

In the commodity markets, oil prices remain under pressure and are drifting back toward the low end of their recent trading range.  One story I saw was that there is a renewed effort to get the ceasefire talks in Gaza back on track, but that seems tenuous at best.  Given the strength seen in the PMI data across Europe and the US, it would seem the demand side of the story would improve things here, but not yet.  As to the metals markets, after a serious two-day correction, this morning is bringing a respite with both gold and silver prices bouncing while copper prices remain unchanged.  I remain of the view that the longer-term picture for metals is still intact, so day-to-day trading activity should be taken with a grain of salt.  Ultimately, I continue to believe that the central banking community is going to cut rates before inflation is controlled and that will lead to much bigger problems going forward along with much higher commodity prices.

Finally, the dollar, which rallied alongside yields yesterday, is giving back some of those gains, albeit not very many of them.  The commodity currencies (AUD +0.2%, NZD +0.2%, ZAR +0.4%, NOK +0.6%) are the leading gainers this morning although the euro is also firmer as is the pound despite much weaker than expected UK Retail Sales data.  Alas, the poor yen can find no support and continues to drift a bit lower, with the dollar back above 157 this morning and keep an eye on CNY, which is now back above 7.25 for the first time in a month after Chinese FDI data showed larger than expected -27.9% decline.  It seems that President Xi has successfully scared off most foreign investment which is very likely a long-term problem for the nation.  While it has been very gradual, the fixing rate continues to weaken each day as it appears the PBOC is finally accepting the need for a weaker yuan.

On the data front, we see Durable Goods (exp -0.8%, +0.1% ex-Transports) and then Michigan Confidence (67.5) which continues to be a problem for President Biden’s reelection campaign as the people in this country are just not happy.  We also hear from Governor Waller this morning.  It will be very interesting to hear him as my anecdotal take is that the regional presidents have been much more hawkish than the governors and Chairman Powell, so if he leans dovish, it may demonstrate a bigger split between factions on the board than we have been led to believe.  We shall see.

Net, it remains very difficult for me to make a case for the dollar to weaken substantially at this time.  While it may not power ahead, a decline seems unlikely for as long as higher for longer remains the mantra.

Good luck and good long weekend

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There will be no poetry on Monday due to the holiday.

Wages on Fire

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The ECI data’s designed
To help understand what’s enshrined
In hiring workers,
Including the shirkers,
With numbers quite nicely streamlined
 
The problem for Jay and the Fed
Is yesterday’s data brought dread
It rocketed higher
With wages on fire
And showing that rate cuts are dead

It’s funny the way things work.  Historically, the number of people who paid attention to the Employment Cost Index (ECI), even in financial markets, could be counted on your fingers and toes.  It was just not a meaningful datapoint in the scheme of the macro conversation.  And yet, here we are in extraordinary times and suddenly it is a market mover!  I have updated yesterday’s 10-year graph with the most recent print of 1.2% and it is now very evident that wage pressures are not dissipating at all.  Rather, they seem to be accelerating and that is not going to help Jay achieve the 2.0% inflation goal.

Source: tradingeconomics.com

But in fairness, it wasn’t just the ECI.  Yesterday’s data releases were lousy across the board.  Case-Shiller Home prices rose more than expected, by 7.3% Y/Y.  Chicago PMI fell sharply to 37.9, far below expectations and I guess we cannot be surprised that, given all that, Consumer Confidence fell to 97.0, its lowest reading since immediately after the pandemic.  The upshot is rising prices and weakening growth, back to fears of stagflation.  With that as backdrop, the fact that risk assets got slaughtered across the board yesterday seems par for the course. 

And that is the setup for Jay and his merry band at the FOMC today.  At this point, much ink has already been spilled trying to anticipate what the statement will say and how hawkish/dovish Powell will be at the press conference so there is very little I can add that will be new.  I would contend the consensus is that the statement will be more hawkish, likely removing the line about “Inflation has eased over the past year but remains elevated,” or adjusting it.  However, one of the things that has been pointed out lately is that Powell’s press conferences seem to have consistently been more dovish than the statement.  Perhaps that happens again today, but I have to have some faith that Powell is actually trying to achieve the mandates and it is abundantly clear that right now the price side of the mandate is in jeopardy.  As there are no dots or ‘official’ forecasts coming, my take is a slightly more hawkish statement and Powell backing that up later.

I guess the biggest question, especially after yesterday’s data, is how he will respond to questions regarding hiking rates further.  If I were him, I would have that answer prepared to be as nondescript as possible. Because if he opens up that avenue of discussion, we are going to see a much more serious decline in risk assets.

One other thing of note yesterday was a comment by Secretary Yellen which was almost laughable when considering who is making the statement.  Apparently, she is,” concerned about where we’re going with [the] US deficit.”  Seriously?  She is the Treasury Secretary in charge of spending plans and after pitching for ever more money to spend she is now concerned about the budget deficit?  Then, apparently according to Axios, in a speech later today she is set to make a plea for the Fed’s independence!  Again, seriously?  The Fed is ostensibly already independent, yet I’m pretty certain she is bending Powell’s ear daily about what to do, i.e., commingling Treasury and the Fed.  But suddenly she is concerned about its independence?  It is things like this that make it so difficult to take certain players on the stage seriously.  It doesn’t speak well of the current administration’s efforts to fix the problems that exist, many of which they have initiated.

Ok, enough ranting on my part.  As it is May Day, much of Europe and some of Asia was closed last night but let’s recap the session as well as look ahead to the data before the FOMC.  I’m pretty sure you know how poorly the equity markets behaved yesterday with -1.5%- to -2.0% losses in the US.  In Asia, the markets that were open, Japan, Australia and New Zealand followed the same course, falling, albeit not quite as far, more on the order of -0.5% to -1.0%.  in Europe, only the FTSE 100 is trading today, and it is flat on the session while US futures are pointing lower again, down -0.3% or so at this hour (7:00).

In the bond market, after yesterday’s Treasury selloff with yields jumping 8bps across the curve, markets are quiet with Europe on holiday so no change ahead of the NY opening.  The rise in Treasury yields did drag European sovereign yields up as well, just not as far with most higher by 3bps-4bps yesterday and they are closed today.  As to JGB yields, despite all the huffing and puffing in the FX market, they are essentially unchanged so far this week.

But the real fun yesterday was in the commodity markets with significant declines across the board.  Oil prices fell on a combination of higher inventories according to the API as well as hopes of a ceasefire in Gaza helping to settle things down in the middle east.  And they are lower by another -1.5% this morning.  Meanwhile, metals markets, which had been exploding higher across the board until two days ago, had another wipeout yesterday with all the metals falling by 1% or more.  This morning, though, they seem to have found some support with gold (+0.1%) and silver (+0.5%) bouncing slightly while copper (-0.8%) and aluminum (-0.3%) are still under pressure given the weaker economic data.  Of course, underlying all this movement is concerns that interest rates are going to continue higher.

Which brings us to the dollar, which, not surprisingly given the rise in interest rates, rose sharply yesterday and is holding those gains this morning.  On average, I would say the dollar gained 0.5% yesterday and it was broad based, rising against both G10 and EMG currencies as well as against financial and commodity currencies.  For instance, CLP, which is closely linked to copper prices, fell -2.0% yesterday while ZAR was lower by -1.0%.  But the euro (-0.6%) and pound (-0.4%) were also under pressure as traders started to anticipate an even more hawkish Fed today.  I suspect things will be quiet until the FOMC this afternoon despite the data that is due.

Speaking of that data, first thing we get the ADP Employment report (exp 175K) then JOLTS Job Openings (8.69M) and ISM Manufacturing (50.0).  A little later comes the EIA oil inventory data and then, of course, the FOMC statement at 2:00 with the press conference at 2:30.  Since all eyes are focused on that, I would not expect much activity until it is released, and Powell speaks.

Good luck

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Stagflation

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Call rates will remain
Zero to Point-one percent
We’ll still purchase bonds

 

In a move that clearly captured my heart, the BOJ left policy on hold last night, as widely expected.  But the key is that the policy statement, in its entirety, is as follows:

I would contend they could have used my haiku above and completely gotten the message across!  This is the best central bank move I have seen in forever, an economy of words with limited discussion about their views of the future.  But that the Fed would be so terse in their statements.  By forcing investors and traders to consider all the issues and the best, or at least possible, ways in which the central bank can achieve their stated goals, positioning would be substantially reduced because nobody would think the central bank ‘had their back’.  This would prevent another SVB-type collapse, and probably go a long way to reducing the massive wealth inequalities that central banks have fostered since the GFC.  Just sayin’!

The market response to this, and the subsequent Ueda press conference was to sell the yen even more aggressively, with USDJPY touching yet further new 34-year highs at 156.80, higher by more than one full yen (0.7%) and JGB yields climbed to 0.92%, slowly approaching the big round number of 1.00%.  FinMin Suzuki was out trying to talk the yen higher (dollar lower) with the following comments, “the weak yen has both positive and negative impacts, but we are more concerned about the negative effects right now.”  Those comments were sufficient to drive USDJPY down about 90 pips in a few minutes, but as of right now (6:20), the dollar is back to its highs.  As long as the Fed and the BOJ remain on different wavelengths, the yen will not be able to rally, trust me.

The GDP data surprised
By showing less strength than surmised
But really, for Jay
The prob yesterday
Was PCE so energized

This brings us to the GDP data yesterday, which missed badly at 1.6%.  However, that was not the worst part of the report.  Alongside the GDP data, there is a PCE calculation, that while not the one on which the Fed focuses, is still a harbinger of how things are going.  That number was higher than expected with the Core rising 3.7% Q/Q, up from 2.0% in Q4.  The upshot of this data was that growth is slowing and inflation is rising, exactly the opposite of the Fed’s (and the administration’s) goals and moving toward the concept of stagflation.

While quoting oneself is not the best etiquette, I think it makes some sense here as I described this exact situation back in January as follows:

Stagflation is an awful word as it describes a state
Where prices rise too fast while growth just cannot germinate.
And this, dear friends, is what I fear will come to pass this year
By Christmas, bonds and stocks will fall while metals hit high gear.

It should be no surprise that both bonds and stocks fell yesterday as market participants are growing concerned that the Fed has lost control of the narrative.  After all, the last time we had stagflation, Chairman Volcker chose to fight inflation first by raising the Fed funds rate to 21% and driving the economy into a double-dip recession from 1980-1982.  But the debt/GDP ratio at the time was just 30% or so and the government could afford it.  That is not the case today, and quite frankly, there are exactly zero politicians on either side of the aisle who can tolerate a recession of any type, let alone a double dip.  My guess is that all hands will be pushing to increase the rate of growth and let inflation rip because given the current drivers of inflation (commodity prices, near-shoring and demographics), it is not clear the Fed can do anything about it anyway.  Don’t you feel better now?

All this leads us to this morning’s PCE data (exp 0.3% M/M for both headline and core, 2.6% Y/Y for both readings) as well as Personal Income (0.5%) and Personal Spending (0.6%).  Given yesterday’s outcomes and the fact that the Bureau of Economic Analysis produces both sets of numbers, the whisper number is clearly higher.  If that should manifest, I suspect that the price action from yesterday, lower stocks and bonds, is very likely to continue despite the after-market rally of both Google and Microsoft on better-than-expected earnings data.  I also suspect that before noon, the Fed whisperer, Nick Timiraos, will have an article out in the WSJ to give some Fed perspective as they are currently muzzled in their quiet period.            

I don’t think there’s anything else to say about this, so let me recap the overnight session, at least the parts I have not yet discussed.  While the US equity session did not finish on its lows, all three major indices were lower by at least -0.5% on the day.  However, the same was not true in Asia with the Nikkei (+0.8%) responding positively to the fact that tighter monetary policy was not on its way, while Chinese (+1.5%) and Hong Kong (+2.1%) shares positively ripped on the back of the strong tech earnings in the US.  As to European bourses, they are all in the green this morning, with Spain (+1.1%) leading the way but all higher by at least +0.5%.  Lastly, US futures are pointing higher as well after the strong earnings numbers overnight, up by +1.0% or so at this hour (7:20).

After jumping 8bps in the wake of the GDP data yesterday, 10-year Treasury yields slid a bit and finished the day up 5bps.  This morning, they have given back two more basis points, but still trade right at 4.70%.  If this morning’s data is 0.4%, watch for another sharp move higher in yields today.  European yields pretty much followed the US yesterday, all closing higher by between 4bps and 6bps, and this morning they are lower by similar amounts, right back to where they started.

Oil prices (+0.5%) are climbing higher again, seeming to have found a recent bottom and looking like they are set to push back toward $90/bbl by summer.  While the real GDP data was softer, nominal remains solid and that is what drives demand.  In the metals markets, they all jumped on the data release and this morning are continuing higher (Au +0.7%, Ag +0.8%, Cu +0.8%, Al +0.9%).  In the industrial metals, inventories are dropping while the precious space is clearly responding to the inflation fears.

Finally, the dollar is little changed overall this morning.  while it has rallied sharply vs. the yen, ZAR (+0.85%) is gaining on metal market strength as an offset and pretty much everything else is +/- 0.25% or less.  My take is everyone is waiting for this morning’s data to determine if the Fed is going to become even more hawkish, or if there will be a reprieve. 

In addition to the PCE data, we get Michigan Sentiment at 10:00 (exp 77.8, down from 79.4).  Right now, players are holding their collective breath for the numbers.  After the release, it’s all about the results.  Given that every recent inflation print has been on the high side, I expect this to be no different.  Bonds should suffer, commodities should outperform, and I expect the dollar to do well.

Good luck and good weekend

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Showing Concern

Posted on by

Investors are showing concern
And, risk assets, starting to spurn
But this time, it seems
That only in dreams
Are bonds something for which they yearn
 
Instead, the two havens of note
As evidenced by every quote
Are dollars and gold
Which folks want to hold
While stock bears are starting to gloat

 

**There will be no poetry for the rest of the week as this poet will be seeking rhythm only in his golf swing for a few days.  I will return on Monday, April 22.**

It appears that investors are beginning to ask more serious questions about the macroeconomic outlook and whether the current valuations in financial markets are representative of the future.  Not only did equity markets suffer significant declines yesterday, but so did bond markets.  At the same time, geopolitical tensions continue to rise driving even more risk reticence.  While it is still far too early to claim that things have turned decisively, it is certainly worth a discussion as to whether that may be a valid explanation.

I would paint the big picture in the following manner:

  1. US economic activity remains firm although there are still pockets of weakness.
    1. Retail Sales printed much higher than expected at +0.7% with a revision higher to last month’s data up to +0.9%.
    1. Empire State Manufacturing improved from last month to -14.3 but was worse than the expected -9.0.
  2. The Fed continues to downplay the probabilities of rate cuts in the near future.
    1. Daly: “The worst thing we can do right now is act urgently when urgency isn’t necessary.  The labor market’s not giving us any indication it’s faltering, and inflation is still above our target, and we need to be confident it is on the path to come down to our target before we would feel the need – and I would feel the need – to react.”
  3. Concerns over the next step in the evolving Israel/Iran conflict have market participants (and the rest of us) on edge.
    1. Bloomberg Headline: Israel Vows Response to Iran as US and Allied Urge Restraint.
    1. Reuters headline: Iran Says Any Action Against its Interests will get a Severe Response.

Clearly, there are other issues as well, with the ongoing Russia/Ukraine conflict, the critical elections upcoming, not only in the US but in Mexico, India and several German states, and confusion on the Chinese economy.

My point is that uncertainty is very high, and rightly so.  It is a fraught time in the world.  Historically, in this situation, US Treasuries were the place to where so many global investors would run.  The dollar would often benefit from this flight to safety, while risky assets, especially stocks, would suffer.  But it appears this generation of investors did not get the memo on how they are supposed to respond.  Instead, they seem to be looking at the ongoing fiscal profligacy in the US and the very real likelihood that inflation is not going to be declining anytime soon and decided that being long duration is a losing proposition.  Instead, the things that are in demand are dollars (with the highest cash yield around) and gold, with no yield, but with a long history of maintaining its value in both good times and bad.

Quite frankly, it is hard to argue with this sentiment, at least in my view.  I have long maintained that inflation was going to be stickier than many Fed and analyst models had forecast over the past several years.  I see no reason for the Fed to cut rates anytime soon.  Rather, while I expect that there may be ample reason to consider rate hikes going forward, given their inherent bias to cut, the outcome will be Fed funds remaining at their current level for much longer than most people expect.  Think, through mid-2025 at least.  

In this situation, absent a significant economic downturn, which doesn’t appear imminent, I continue to look for a bear steepening of the yield curve with 10yr yields rising above 5.0% and possibly as high as 5.5%.  In fact, this is exactly what the US needs to address its debt problem, high nominal GDP growth, high inflation, and negative real interest rates.  My fear is that the Fed will resort to Yield Curve Control, keeping the entire interest rate structure at an artificially low level in order to speed this process along.  This was the playbook immediately after WWII and it worked.  Do not be surprised to see them repeat that strategy.

If this is the way things evolve, protecting the value of your assets will require holding commodities and precious metals, real estate and some equities.  Both cash and bonds will be terrible investments in that environment, and equity selection will be important as not all will do equally well.  Value over growth is likely to be the play.  

In the meantime, let’s look at the wreckage from last night.  After the second down day in a row in the US, with red everywhere, Asia followed suit as both Japan (Nikkei -1.9%) and Hong Kong (-2.1%) really suffered while the mainland (-1.1%) was less awful after the Chinese data dump.  Surprisingly, Q1 GDP there rose 5.3%, better than expected and more than last quarter, but Retail Sales (3.1%, exp 4.5%) and IP (4.5%, exp 5.4%) both showed weakness compared to last month as well as expectations.  It seems odd that GDP was so firm with weak underliers.  Perhaps we should take this data with a grain or two of salt!  As to the rest of the regional markets, they were all in the red as well.

The picture is no better in Europe with red across the board, mostly on the order of 1.1% or more.  The only noteworthy data was German ZEW which showed current conditions to be horrible but expectations, for some reason, brightening.  As to US futures, at this hour (7:30) they have turned slightly green, up about 0.3% across the board.

In the bond market, yields around the world continue to rise as inflation concerns remain top of mind everywhere, or at least here in the States and since the US leads the parade in the global bond markets, everyone is following.  Yesterday saw 10-year yields climb 4bps and this morning they are a further 5bps higher, now sitting at 4.64%.  European yields are also firmer, up between 2bps and 4bps throughout the continent, but did not see as much of a move yesterday.  Regardless, it is pretty clear that investors are shying away from duration.  Even JGB yields are edging higher, up 1bp overnight, although they continue to badly lag the US situation, and that continues to weigh on the yen.

Oil prices, which rallied yesterday are consolidating those gains and edging lower this morning, down -0.4%.  The geopolitical concerns remain top of mind for traders, but economic forecasts are also key.  After all, if China truly is growing, that implies an uptick in demand which should be supportive overall.  Thus far, the middle east conflict has not targeted oil infrastructure, but if that changes, watch for much higher prices.  In the metals markets, yesterday saw strength across the board which is reverting this morning.  The biggest change in this market is that it has become far more volatile than its recent history.  I expect that will be the case in all markets going forward as uncertainty remains a key feature of the entire macro story.  Net, the metals have been rallying sharply for the past month or more, so this morning’s modest declines are more corrective than indicative in my view.

Finally, the dollar is ‘strong like bull!’  At least that has been the case for the past week or more as, especially the yen (-0.3% today, -1.9% in the past week), continues to lack buyers anywhere.  While I believe that the BOJ/MOF are less worried about the actual rate, the reality is that the yen is starting to decline pretty quickly.  If I were a hedger who needed to sell yen to hedge assets or revenues, I would be using options here, probably zero-premium collars, as you cannot be surprised if intervention is on the table.  We are just a shade below 155.00 and market talk is of a push to 160.00.  I have to believe that FinMin Suzuki and Governor Ueda are starting to get a little uncomfortable.   Now, the dollar is rising against all its counterparts, having risen more than 2% against many in the past week, but still, the yen’s decline has been consistent for more than two years and is starting to look unruly.

As to the rest of the currencies, this morning sees MXN (-0.6%) and PLN (-0.7%) as the laggards while the euro (+0.15%) has reversed losses from earlier in the session but is still lower by more than 2% since last Wednesday.  As the market continues to price Fed cuts out of the future while other central banks are seen still on track to cut, the dollar will likely keep going.

While we see Housing Starts (exp 1.48M) and Building Permits (1.514M) early and then IP (0.4%) and Capacity Utilization (78.5%) a bit later, the big news is that Chairman Powell will be speaking at the Spring IMF conference this afternoon at 1:15pm.  As well we will hear from Governor Jefferson, NY Fed president Williams and BOE Governor Bailey and BOC Governor Macklem before the day is through.  In other words, there will be a lot of words to digest.  However, none will be as important as Powell’s. if he acknowledges that inflation is hotter than they want and turns more hawkish, watch out for more severe risk asset declines.  But if he doesn’t, it could be even worse!

Good luck for the rest of the week

Adf

Smokin’

Posted on by

The CPI data was smokin’
So, Jay and the doves are now chokin’
He’s lost the debates
And they can’t cut rates
Without, higher prices, provokin’

As such, it should be no surprise
That traders, risk assets, despise
So, bond yields exploded
While stocks all eroded
And dollars made new five-month highs

Welp, the inflation data was not merely a little hot, it was a lot hot.  Measured prices rose 0.4% on both the headline and ex food & energy readings for the month of March with the annual rises ticking higher to 3.5% and 3.8% respectively.  Too, you will not likely hear the inflation doves and those who had been concerned with deflation talking about the trend for the past 3 months or 6 months, as both of those are now running well above 4%.

In truth, if the Fed was both data dependent and actually still fighting inflation, rate hikes would be on the table again as there is absolutely no indication that either wages or rental/housing prices are heading back to the levels necessary to see an overall inflation rate of 2.0%.  Alas, it is also clear that politics is a part of the decision process and the concept of fiscal dominance, where fiscal policy overwhelms monetary policy, remains the order of the day.

Fed funds futures adjusted their probabilities instantly with the idea of a June cut now down to just 16% while there are less than 40bps of cuts now priced in for the rest of 2024.  Given this price action, it is no surprise that bond yields rose dramatically, with the 10-year closing the session at 4.54%, up 18bps and the highest close since November 2023.  My sense is it has further to go.  Meanwhile, 2-year yields rose back to 4.97%, a more than 21bp rise to levels also last seen in November 2023.  One other aspect of the bond market was the worst 10-year auction in more than a year as the tail was 3.1bps, the third largest tail in history, with a lousy bid-to-cover ratio (2.33) and much less foreign interest (61.4%) than we have been seeing lately.  The last 5bps of the yield rally came after the auction result.

Adding to the general gloom, equity prices fell about -1.0% across the board, but closed above their session lows.  It is the dollar, though that really saw a big move with a greater than 1% move against most of its major counterparts.  USDJPY blasted through the 152.00 level that many had thought was a line in the sand for the MOF/BOJ and is a full big figure higher.  Meanwhile, European currencies all declined by more than -1.0% and Aussie (-1.8%) was the absolute laggard across both G10 and EMG blocs.

With this as backdrop, the ECB sits down this morning and must decide if it is too early to cut interest rates.  The economic data continues to underwhelm, and the inflation data is actually trending lower, rather than the situation in the US where it has turned back higher.  But the sharp decline in the euro yesterday has got to be a warning to Lagarde and her minions as a cut, especially since it is not priced at all, would likely see another sharp euro decline, something they are certainly keen to avoid.

One other thing, the Minutes of the March FOMC meeting were released in the afternoon, and it seems the committee is coming to an agreement that they are going to slow the roll-off of Treasury securities, likely cutting it in half to $30 billion/month although they are not going to touch the mortgage-backed part of the balance sheet since that is barely declining at all.  It appears that this may take place at the June or July meeting, but clearly before too long.

Enough about yesterday.  Overnight saw Chinese CPI data fall back to -1.0% M/M, reversing the previous month’s rise, as it becomes ever clearer that China will never be able to consume as much as it is able to produce.  That is the very crux of the trade issues that are becoming more heated as China ultimately dumps all its excess production overseas, or at least tries to.  This is an issue that is not going to disappear anytime soon, and one that will have major political and economic ramifications going forward.  I suspect that the tariff situation will only get worse, and I would not be surprised to see further absolute restrictions on Chinese trade regardless of who wins the US election in November.  As to the market impacts of this story, for now, I believe Xi is more fearful of a capital flight if he allows the yuan to weaken substantially, than he is of annoying the US and the rest of the world because the yuan is too weak.  But, given the clear difference in the trajectories of the US and Chinese economies and inflation stories, pressure for yuan weakness is going to continue.

Turning to this morning’s session, Madame Lagarde and her crew meet, and the market is not pricing in any movement.  June remains the odds-on favorite for the first rate cut, and given the fact that the Eurozone, as a whole, is stagnant from an economic growth perspective, and that price pressures there have been ebbing more quickly, that certainly makes sense.  Of course, after yesterday’s CPI, June is off the table in the US so the ECB will have to act without the ‘protection’ of the Fed.  As mentioned above, the euro declined by more than -1.0% yesterday and is edging lower this morning as well, down -0.1%.  Lagarde’s risk is she follows the path of lower rates, the euro declines more sharply, perhaps to parity or beyond, and that invites a resurgence in imported inflation.  Remember, energy is still priced in USD, so that a weak euro would raise the price of oil products across the continent.  Alas for Madame Lagarde, it’s not clear her political nous will allow her to solve this problem.

Recapping markets overnight, following the US declines yesterday, the Nikkei (-0.35%) also fell, but I think the yen weakness helped mitigate the declines.  Chinese shares were lackluster, slipping slightly both in HK and on the mainland and the rest of the time zone saw a mix of modest gains and losses.  Meanwhile, European bourses are all in the red this morning, with Spain (-0.9%) the laggard, but the average decline probably around -0.5%.  US futures, too, are softer at this hour (7:00), down about -0.3% across the board.  Clearly, there is grave concern that the Fed is not going to help ease global monetary policies.

As further proof that US yields drive global bond markets, yesterday’s CPI data pushed European sovereign yields higher by about 10bps across the board!  This despite the fact that inflation is going in the other direction in Europe.  This morning, those yields are continuing to grind higher, up between 2bps and 4bps across the board.  However, Treasury yields have stalled after yesterday’s dramatic rise.  Let me say that if the PPI data released this morning is hot, I fear things could move much further.

In the commodity space, oil rallied yesterday on stories that Iran was preparing for a more substantial retaliation against Israel and despite the fact that EIA inventory data showed surprising builds in crude and products.  However, this morning it is edging lower, -0.5%.  Perhaps more interesting is gold (+0.2%) which is a touch higher this morning but was able to rebound off its worst levels of the session after the CPI print to close nearly unchanged on the day.  In the end, the market remains quite concerned about inflation regardless of the Fed’s response, and gold continues to get love on that basis.  As to the base metals, yesterday’s rate induced declines were cut in half, but this morning both Cu and Al are drifting lower by about -0.2%.

It is the dollar, though that had the most impressive movement yesterday and this morning, it is holding onto most of those gains.  Absent a hawkish message from the ECB this morning, something which I believe is highly unlikely, the euro feels like it has further to decline.  The BOC left policy on hold and sounded fairly non-committal regarding its first rate cut there.  The Loonie suffered yesterday and has seen no rebound at all.  In fact, the only currencies showing any life this morning are AUD and NZD, both higher by 0.25%, which seems much more of a trading reaction after their dramatic declines yesterday, than a fundamental story.  As long as the Fed remains the most hawkish, the dollar should hold its bid.

Turning to the data today, PPI (exp 0.3% M/M, 2.2% Y/Y) and core PPI (0.2%, 2.3%) lead alongside Initial (215K) and Continuing (1792K) Claims.  Those numbers will arrive 15 minutes after the ECB policy decision is announced with no movement expected there.  Madame Lagarde has her press conference at 8:45 this morning.  We hear from Williams, Collins and Bostic over the course of the day, so it will be quite interesting to find out how far their thinking has changed.  I would be particularly concerned if there is further talk of rate hikes again.  Remember, Bowman intimated that might occur when she spoke last week, and Bostic has been in the one-cut camp so could turn as well.  Let me just say the market is not pricing in that eventuality at all!

At the beginning of the year, I opined that there would be at most one rate cut and rates would be higher by Christmas.  As of this morning, I see no cuts and a very real chance of hikes.  Keep that in mind for its impact on all asset classes going forward.

Good luck
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Stanching Their Bleeding

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For all of those pundits that claimed
inflation had died and been maimed
The data did show
What now we all know
Inflation is still quite inflamed

The upshot is all those who said
That real rates would soon force the Fed
To quickly cut rates
Are in dire straits
And stanching their bleeding instead

Wow!  Not much else you can say after yesterday’s market activities following the hotter than expected CPI data released in the morning.  As I wrote on Monday, a 0.1% difference in a monthly print is not really substantive in the broad scheme of things, but when the narrative is so strong and so many are convinced that the Fed is itching to cut rates because they don’t want to overtighten as inflation continues to fall, that 0.1% in the wrong direction means a lot.  Hence, yesterday’s price action (which I did presage in the last line of my note yesterday morning before the release.)

Of course, you are all aware that stocks got crushed, with the major indices falling -1.35% to -1.80% while the Russell 2000 small cap index fell -4.0%!  But it wasn’t just stocks, bonds joined the fun with the 10-year yield soaring 15bps to 4.30%, its highest yield since early December.  Gold got crushed, falling $30/oz and back below $2000/oz for the first time in two months, while the dollar exploded higher, rising about 1% against most currencies and almost 1.8% against the yen.

A quick analysis of the CPI data shows that the shelter component was the big surprise on the high side, although airfares also were higher than expected.  As well, wages remain much stickier than the Fed would like to see as they continue to support price increases in the services component of the data.  Forgetting the headline for a moment, a look at Median CPI, as calculated by the Cleveland Fed, shows that last month’s rise was 0.5% and the Y/Y number is +4.85%.  That feels to me like a much better estimate of what is happening than the newest darling of the bullish set, Truflation, which claims that inflation is “really” rising at only 1.39% as of yesterday.  One final thing, hopefully, all of those who claimed that the ‘real’ trend of inflation was sub 2% because the 3-month average had fallen there (please look at Monday’s note, What If?) will finally shut up for a while.

The new Mr. Yen
Said “we are closely watching”
So you don’t have to
Do not cross this line!

As mentioned above, the yen was the worst performer yesterday after the data which, not surprisingly, triggered a response from the Japanese government.  Now that USDJPY is back above 150.00, there are many who believe the MOF/BOJ will be intervening soon.  There is a terrific website called Harkster.com which aggregates all sorts of commentary and research from around the web as well as adding their own commentary.  I highly recommend it as a source for information.  At any rate, they have a very nice description of the historical actions that lead to intervention by the Japanese which I show here:

1.     Language such as “monitoring developments in currency markets”.
2.     “Sudden/abrupt/rapid” movements in currency markets are “undesirable”. In addition, markets are “not reflecting fundamentals”.
3.     “Excessive” is introduced next to describe the price movements alongside “clearly” in addition to referring to FX moves as “speculative”.
4.     Readying for action is normally reflected with the phrase “we are ready to take decisive action” which would suggest some action is imminent.
5.     Price checking is the step prior to actual intervention whereby the BoJ will call round selected Japanese banks and ask for a level of USDJPY. Even though they do not deal the act of them asking normally makes the banks, who have been contacted, sell USDJPY in anticipation of intervention and they will also spread the news around the market to encourage more selling.
6.     Same as 5 but this time the BoJ actually do sell USDJPY. This may happen in waves.
7.     Finally, coordinated intervention with other major central banks involved. This would generally happen early NY hours to include the US. This obviously has the most effect on the markets.

Arguably, we are somewhere between numbers 1 and 2 right now, but they can escalate this process quickly.  However, in the end, what matters for currencies over time are relative fiscal and monetary policy settings.  History has shown that to strengthen a currency, a country must run a tight monetary and loose fiscal policy.  To weaken a currency, the opposite is true.  Given the US 7% budget deficits and highest interest rates in the G10 + QT, it is pretty clear that the dollar should be strong.  Now, if the BOJ were to raise rates aggressively, it would have a chance to alter the trajectory of the yen, but while Ueda-san has implied that they may raise rates back to zero after the spring wage negotiations, assuming they agree large increases, unless there is a strong belief that they are going to continue to raise rates to attack inflation in Japan (which isn’t really a big problem) then absent the Fed starting to ease, there is no good reason to think the yen will strengthen very much at all.  Now, if the Fed does start cutting aggressively, that is a different story, but based on yesterday’s CPI, that feels like it is a long way in the future.

And those are the most noteworthy things to absorb.  Now, a look at the rest of the overnight session shows that Japanese stocks were softer, but the rest of Asia (absent China which is still on holiday) was mixed, with gains and losses around.  Europe, this morning, though is firmer, up about 0.5% except the UK, which is higher by 0.9% after CPI there fell more than expected, encouraging talk that the BOE will be cutting sooner.  Now remember, yesterday the UK lagged after their employment data was stronger than expected, especially wage data, so it is not clear which one to believe.  As to US futures, they are firmer at this hour (8:00), up about 0.5%.

After yesterday’s massive yield rallies, it is no surprise to see them slipping a bit today, with Treasury yields lower by 1bp and most European sovereign yields down by 3bps (UK Gilts are -6bps on that inflation data).  Overnight, the Asian session saw government bonds there slide with yields higher across the board although JGB yields were the laggard, rising just 3bps.

In the commodity markets, oil (flat today) is the only market that didn’t sell off yesterday and it has maintained those gains.  This is despite a much bigger inventory build than anticipated as it seems continued concerns over a wider Middle East war are extant, as is a new worry, as Ukraine has been able to bring the attack to Russia more effectively, sinking another Russian ship in the Black Sea last night.  Recall, they have been attacking Russian oil infrastructure and if they are successful in that effort, it will definitely give oil prices a boost.  But the rest of the commodity markets got crushed yesterday with gold, copper and aluminum all falling sharply.  This morning, though, those three markets are little changed, simply licking their wounds and not extending any losses.

Finally, the dollar is also little changed this morning, but that is after a massive rally across the board yesterday against both G10 and EMG currencies.  Against most major counterparts, it has traded back to levels last seen in mid-November, although the pound has been holding up better than most, with smaller net moves.  It is ironic that the dollar strengthens on a high inflation print as fundamentally, high inflation is supposed to weaken a currency.  Of course, this move has nothing to do with inflation per se, and everything to do with interest rate expectations.

On that subject, it is worth noting that the latest Fed funds futures rate cut probabilities are now; March 8.5%; May 37.9%; and there are now just 4 cuts priced into the year, down from 7 about a month ago.

There is no hard economic data released although the EIA oil inventories do come out later this morning.  We also hear from two Fed speakers, Goolsbee and Barr, and I imagine we could get a little ‘we told you so’ in their comments today.

If recent history is any guide, I suspect that equity markets will rebound a bit further early, but potentially drift lower as the day wears on.  The bulls were clearly shaken as their narrative took a big hit.  But this was just one data point of many.  I don’t believe the end is nigh, but in the longer term, it is not hard to believe that the Fed will remain the tightest policymaker of all the central banks and that will help the dollar while hurting risk assets.

Good luck
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