Tag Archives: #riskon

Jay’s Coronation

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The word for today is inflation
With many convinced its cessation
Is just round the bend
So, growth will ascend
Alongside Chair Jay’s coronation
 
But what if inflation don’t slow?
And rather, continues to grow
Can bonds stand the pain?
Will stocks feel the strain?
Or will we go on with the show?

The first thing to mention is the Bitcoin ETF was approved by the SEC last evening and the price…is basically unchanged.  As I mentioned yesterday, it seems quite ironic that Bitcoin, a shining symbol of freedom from the government and regulation is now tightly ensconced in government and regulation.  Do not be surprised if it becomes a much less interesting asset having lost one of the key things that makes it different.  Just a thought.

Ok, on to the more important stuff, the economy and today’s CPI report.  Current consensus forecasts are as follows: CPI 0.2% M/M (3.2% Y/Y) and -ex food & energy 0.3% M/M (3.8
% Y/Y).  If realized, these represent a 0.1% rise in the headline and 0.2% decline in the core readings from last month on an annual basis.  Now, in the broad scheme of things, and more importantly, in our day-to-day lives, that 0.1% or 0.2% has absolutely no meaning or impact.  However, the importance allotted to that 0.1% is remarkable.  Entire narratives will be spun about how the Fed has been amazing in their ability to achieve a soft landing, or the Fed is a group of 17 incompetent fools based on an estimated data point that is often revised and does not clearly measure what the words in its name describe.  As such, let’s simply focus on the market reaction function rather than the meaning of the data.

Heading into the release, my take is that given the recent run of softer than forecast inflation readings around the world, whatever the economists and analysts have forecast, the market is leaning toward a soft print.  The fact that oil prices fell about -6% during the month of December, although gasoline prices were nearly unchanged, has tongues wagging.  As well, discussions about slowing growth in China and their negative PPI as a driver of deflation is another key element of the narrative. 

Counter to this is the fact that the Fed refuses to take their victory lap.  Yesterday, John Williams explained, “My base case is that the current restrictive stance of monetary policy will continue to restore balance and bring inflation back to our 2% longer-run goal.  As inflation comes down over time, my expectation is interest rates will also come down over time.”  In other words, things are going well, but we have not reached the finish line.  This certainly didn’t sound like someone who was ready to cut interest rates in two months’ time although the market continues to price a better than 2/3 probability that the Fed will do just that.  Now, if we take him at his word and inflation fell another 0.6% or more by March, maybe that would be enough to get them into a cutting mood.  But I just don’t see that.

One of the things that is often either overlooked or not well understood is the fact that things move REALLY slowly in the economy, especially when it comes to measured moves of economic data points.  Of course, the exception that proves this rule was the Covid recession, but in order to get data to move at the same speed as markets required virtually every government in the world to shut their economies down at the point of a gun!  My take is that will not happen again in our lifetimes, regardless of the threat.  As such, we need to recognize that, to use a well-worn metaphor, the economy is an aircraft carrier and turning it takes time.  

When applying this concept to inflation, and prices more generally, especially wages, they don’t move that quickly.  In fact, they move quite slowly.  People get annual raises, not weekly or monthly ones.  While gasoline prices move up and down on a daily basis, the same is not true for menu prices, items in the supermarket or rent.  Real-time price adjustments are a flaw feature of financial markets, not of real life.  While many will point to the fact that the shelter portion of CPI (and PCE) is a smoothed average of the past twelve months and so not indicative of today’s situation, I would counter that most of the people who pay rent haven’t moved in the past twelve months and their rent remains the same.  It is certainly not declining, and I am still looking for that first story of the landlord who saw the CPI data slipping and cut his tenants rent to keep in line!  

The point is that expectations of a sharp move in a slow-moving data series are misplaced.  Much has been made of the fact that if you annualized the last 3 months or 6 months of CPI monthly data, CPI is already below the Fed’s target of 2.0% and so they should be cutting.  Personally, I find that ridiculous.  But more importantly, the Fed, as evidenced by Williams’ comments above, has no truck with that idea.  Add to this the fact that growth seems to be holding in at trend or better, despite interest rates being “too high” according to the cutting advocates, and it becomes that much harder to believe the Fed is ready to go.

Net, regardless of today’s number, the Fed is not going to change its mind soon.  Markets, however, are a different story.  If the readings are soft, look for a big rally in both stocks and bonds, for the dollar to fall, and for commodity prices to rally nicely.  At least initially.  And the converse should be true as well, a hot number will see red numbers in the stock market, higher yields, a stronger dollar and commodities come under pressure.

Leading up to the number, here’s what we see.  After a nice day in the US yesterday, Asian markets were all in the green led by the Nikkei continuing its rip higher, but this time dragging Chinese shares along for the ride.  In Europe, it appears things are more circumspect as they await the CPI data with most markets +/- 0.2% or less on the day while US futures are currently (7:30) modestly in the green.

Bond yields are definitely in the low inflation reading camp as Treasury yields have fallen 4bps this morning and we are seeing similar movement all across Europe.  The one exception to this story is Japan, where JGB yields edged higher by 2bps despite a couple of soft Leading Economic Index numbers.  However, since the peak, just below 1% in early November, this trend remains clearly lower for yields.

Apparently, the hijacking of an oil tanker in the Persian Gulf has been seen as an escalation of the situation there and oil prices are higher by nearly 2% this morning, although that simply takes the weekly change back to flat.  Gold prices are rallying, 0.5%, and not surprisingly in this environment, so are base metals prices with both copper and aluminum higher by 0.6% this morning.

Finally, on the dollar front, it is lower after a small decline yesterday.  This is of a piece with the inflation expectation story and the idea that the Fed is preparing to cut rates, boost stocks and undermine the dollar.  Even the yen has rallied a bit today, so no currencies are really bucking the trend of a weak dollar, whether G10 or EMG.

Aside from the CPI data, as it’s Thursday we also see Initial (exp 210K) and Continuing (1871K) claims and then early this afternoon we hear from Tom Barkin again.  At this stage, the Fed seems to be of a mind that things are going well, and they are not about to rock the boat in either direction.  Absent a huge surprise in the data this morning, I think this slow grind toward risk on continues.

Good luck

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Sufficiently

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Said Madame Lagarde, I don’t care

‘Bout dovishness seen over there

Though I’m not omniscient

We need rates sufficient-

Ly high til inflation is rare



The Old Lady’s governor, too

Expressed that no cuts were in view

But can both withstand

More slowing than planned

And, with their tough talk, follow through?

A little housekeeping to start this morning.  Today will be the last poetry until January 2nd when I will publish my ‘crystal ball’ viewings in a long-form poem.  For all my readers, thank you for reading and have a wonderful Christmas, Hannukah (I know it’s’ over), Kwanzaa, Festivus or whichever holiday is important as well as let’s hope 2024 is a fantastic new year.

So, let us review yesterday’s activity, and then, more broadly, the state of things as we come to the end of the year.

Arguably, the biggest news yesterday was not that the ECB left rates on hold, which was universally expected, but that Madame Lagarde tried very hard to continue to sound hawkish despite the Fed’s turn on Wednesday.  “Based on its current assessment, the Governing Council considers that the key ECB interest rates are at levels that, maintained for a sufficiently long duration, will make a substantial contribution to this goal. The Governing Council’s future decisions will ensure that its policy rates will be set at sufficiently restrictive levels for as long as necessary.” [emphasis added.]

As well, she explicitly mentioned that there was no discussion of interest rate cuts in the meeting.  The hawks on the committee managed to get a bone thrown their way with the announcement of a phased exit from the PEPP program starting in the second half of next year.  At the same time, their staff projections for GDP growth and inflation were all reduced slightly for 2024 and 2025 with low numbers penciled in for 2026.  She maintained that inflation has been “too high for too long”, clearly true, and has been unwilling to consider anything but their inflation fight.

Alas, this morning’s Flash PMI data releases make ugly reading with French, German and the Eurozone overall reading weaker than last month and weaker than expected.  The Eurozone growth engine has been stalling for quite a while despite falling energy costs.  And now, in the wake of the Fed turning dovish, energy costs are rebounding which will almost certainly negatively impact the continent’s growth trajectory.  Maybe Lagarde can hold out for another month, but I suspect if the data continues to erode in the manner, it has recently, the ECB will recognize that the worst is over and it’s time to alter policy, just like the Fed has done. As well, given the economy in Europe is in far worse shape than here in the US, I expect that they will be cutting more quickly as 2024 progresses.  That will not help the euro, but that is a story for some time next year, not for the remainder of this one.

At almost the same time, the BOE also maintained their policy rate and also indicated that they were not anywhere near ready to cut rates.  In fact, 3 voters wanted a 25bp rate hike, which given inflation in the UK is the highest in the western world, with core still at 5.7%, makes sense.  But, as on the continent, economic activity continues to stumble along, with manufacturing, according to this morning’s Flash PMI reading of 46.4 in recession although Services activity, 52.7 does seem to be rebounding.  However, here, too, I believe the gravitational pull of a dovish Fed is going to quickly weigh on the BOE and we are going to see a pivot in the first half of next year amid weaker growth and slowing inflation.

One final note from yesterday was that Retail Sales were a bit stronger than expected, rising 0.3% and failing to show the slowdown that would be expected to help reduce inflationary pressures.  And just think, that was before the Fed pivot, which has ignited a massive risk-on rally in assets and likely will juice things even more in the short-term.

The result of these policy decisions is that stocks are rallying pretty much everywhere in the world, bonds are rallying pretty much everywhere in the world, commodities prices are rallying, and the dollar is falling.  Not only that, I see nothing that is likely to change those views until somewhere toward the end of Q1 2024 at the earliest.

But let’s step back for a moment and consider the medium-term impacts of all this change.  Remember this, a soft-landing is merely the last stop in the cycle before a hard landing.  The soft-landing narrative is clearly the majority view and driving force in markets as 2023 comes to a close.  But is that a realistic outcome?  

I think a very strong case can be made that we have seen the bulk of the disinflationary forces that are coming as the combination of Covid driven supply chain issues being fixed and higher interest rates / QT has weighed on marginal demand.  It has been a fun story while it lasted and has certainly cheered markets.

But structural issues remain, many of which are outside any central bank’s abilities to address adequately.  Consider what I believe is the biggest structural change, the turn from capital-focused economic policies to labor focused economic policies.  This is inherently inflationary and regardless of what Powell or Lagarde or Ueda or anyone in that chair does, this change is going to continue.  It is a political change, and one that is only getting started.  Politically, we call it populism, and one need only read the papers to recognize this is the new world.

For 40 years, since the Reagan/Thatcher leadership, the world has seen low inflation from a combination of demographics and globalization creating downward pressure on wages and reduced taxation increasing the return on capital.  This led to the financialization of western, especially the US, economies and expanded the wealth/income gaps that are prevalent around the world today.  

But this is changing, and changing far more rapidly than the current governments in power would like to see or believe.  As I wrote earlier, 2016 was a test run for what is looming in 2024.  Consider the populist views of recent election outcomes in Argentina and the Netherlands as well as the rise in the polls of the National Front in France, AfD in Germany, and the strength of both Trump and RFK Jr in the US, with populism as the driving force.  2023 saw more labor unrest in the US than any time in the past 20 years and harkens back to conditions in the 60’s and 70’s.  The big difference between now and then is that union membership has declined so dramatically in the interim.  Do not be surprised to see unions rise again in popularity.

But populism drives more than labor unrest, and ultimately rising wages, it also encourages governments to consider trade barriers and tariffs, both of which drive consumer prices higher.  And populism is very easy for governments to adopt because it sounds so good.  Consider the key tenets; buy domestic goods, limit immigration and tax the rich so they pay their fair share.  We will hear some version of these policies in every country around the world in 2024, and not just western nations, but communist bloc countries as well.  

If this is the future, and I believe it is, then the current risk rally is merely a hiatus before things turn much worse.  In a populist driven society, profit margins are going to decline, and capital will flee to where it feels safest.  That may be whichever nations push back against this trend, although they will be few and far between, and things like real assets, commodities, and real estate.  While I believe this will be the general trend, from an FX perspective, given everything is relative there, strength or weakness will depend on the relative decisions made in each nation.  Arguably, the less populist the decision outcomes, the stronger the currency, but ex ante, there is no way to know how that will turn out.  If I had to bet now, I would suggest that the nation least susceptible to this wave is Japan, a truly homogenous society, and that bodes well for the yen going forward.

In the meantime, as I head off, here are today’s data points with Empire State Manufacturing just released at a much worse than expected -14.5.  We are due to see IP (exp 0.3%), Capacity Utilization (79.1%), and the Flash PMI’s (Mfg 49.3, Services 50.6).  Through the rest of the month, the most important data point will be the PCE data on the 22nd, but arguably, Powell already told us it is not going to be hot, that’s why he turned away from higher for longer.

Today is triple witching in the equity markets, with stock options, future options and futures all expiring, so volume should be high and movement can be surprising.  But the trend right now is positive for risk assets, and I believe that will continue through the holidays and into January.

Good luck, good weekend and have a wonderful holiday

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Miles Off Base

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This poet was miles off base

As Powell, more growth, wants to chase

So, hawks have been shot

With nary a thought

While doves snap all stocks up apace.



It seems clear that Jay and the Fed

Decided inflation is dead

Through Q1 at least

Bulls will have a feast

Though after, take care where you tread

It turns out that not only were my tail risk ideas wrong, I was on the wrong side of the distribution!  Powell has decided that the soft-landing narrative is the best estimator of the future and wants to make sure the Fed is not responsible for a recession.  Concerns over inflation, while weakly voiced, have clearly dissipated within the Eccles Building.  I hope they are right.  I fear they are not.

In fairness, once again, yesterday I heard a very convincing argument that inflation was not only going to decline back to the Fed’s target of 2.0%, but it would have a 1 handle or lower by the middle of 2024 based on the weakening credit impulse that we have seen over the past 18 months.  And maybe it will.  But, while there is no question that money supply has been shrinking slowly of late, which has been a key part of that weakening credit impulse story, as can be seen from the chart below based on FRED data from the St Louis Fed, compared to the pace of M2 growth for decades, there are still an extra $3 trillion or so floating around the economy.  Iit seems to me prices will have a hard time falling with that much extra cash around.

Of course, there is one other place that money may find a home, and that is in financial assets.  So, perhaps the outcome will be a repeat of the post-GFC economy, with lackluster growth, and lots of money chasing financial assets while investors lever up to increase returns.  My guess is that almost every finance official in the world would take that situation in a heartbeat, slow growth, low inflation and rising asset prices.  The problem is that series of events cannot last forever.  As is usually the case with any negative outcome, the worst problems come from the leverage, not the idea.  When things are moving in one’s favor, leverage is fantastic.  But when they reverse, not so much.

A little data is in order here.  According to Statista, current global GDP is ~$103 trillion in current USD, current global stock market capitalization is ~$108 trillion, and the total amount of current global debt is ~$307 trillion according to the WEF.  In a broad view, the current debt/equity ratio is about 3:1 and the current debt/sales ratio is the same.  While this is not a perfect analogy, usually a debt/equity ratio of 3.0 is considered pretty high and a company that runs that level of debt would be considered quite risky.  Now, ask yourself this, if economic activity only generates $108 trillion, how will that >$300 trillion of debt ever be repaid?  The most likely answer is, it never will be repaid, at least not on a real basis.

If you wonder why central bankers favor lower interest rates, this is the primary reason.  However, at some point, there is going to be more discrimination between to whom lenders are willing to lend and who will be left out because they are either too risky, or the interest rate demanded will be too high to tolerate.  When considering these facts, it becomes much easier to understand the central bank desire to get back to the post-GFC world, doesn’t it?  And so, I would contend that Chairman Powell has just forfeited his efforts to be St Jerome, inflation slayer. 

The implication of this policy shift, and I would definitely call this a policy shift, is that the near future seems likely to see higher equity prices, higher commodity prices, higher inflation, first higher, then lower bond prices and a weaker dollar.  The one thing that can prevent the inflation outcome would be a significant uptick in productivity.  While last quarter we did see a terrific number there, +5.2%, the long-term average productivity growth, since 1948 is 2.1%.  Since the GFC, that number has fallen to 1.5%.  We will need to see a lot more productivity growth to keep goldilocks alive.  I hope AI is everything the hype claims!

Today, Madame Christine Lagarde

And friends are all partying hard

Now that Jay’s explained

Inflation’s restrained

And rate cuts are in the vanguard



This means that the ECB can

Lay out a new rate cutting plan

The doves are in flight

Which ought to ignite

A rally from Stuttgart to Cannes

Let’s turn to the ECB and BOE, as they are this morning’s big news, although, are they really big news anymore?  Both these central banks have been wrestling with the same thing as the Fed, inflation running far higher than target, although they have had the additional problem of a much weaker economic growth backdrop.  As long as the Fed was tightening policy, they knew that they could do so as well without having an excessively negative impact on their respective economies.  But given that pretty much all of Europe is already in recession, and the UK is on the verge, their preference would be to cut rates as soon as possible.  

But yesterday changed everything.  Powell’s bet on goldilocks has already been felt across European markets, with rallies in both equity and bond markets in every country.  The door is clearly wide open for Lagarde and Bailey to both be far more dovish than was anticipated before the FOMC meeting.  And you can be sure that both will be so.  While there will be no rate cuts in either London or Frankfurt today, they will be coming soon, likely early next year.  

At this point, the real question is which central bank will be cutting rates faster and further, not if they will be cutting them at all.  My money is on the ECB as there is a much larger contingent of doves there and the fact that Germany and northern European nations are already in recession means that the hawks there will be more inclined to go along for the ride.  Regardless, given the Fed has now reset the central bank tone to; policy ease is ok, look for it to happen everywhere.

Right now, this is all that matters.  Yesterday’s PPI data was soft, just adding fuel to the fire.  Inflation data that was released this morning in Sweden and Spain saw softer numbers and while Retail Sales (exp -0.1%, ex autos -0.1%) are due this morning along with initial Claims (220K), none of this is going to have a market impact unless it helps stoke the fire.  Any contra news will be ignored.

Before closing, there are two things I would note that are outliers here.  First, Japanese equity markets bucked the rally trend, with the Nikkei sliding -0.7% and the TOPIX even more (-1.4%) as they could not overcome the > 2% decline in USDJPY yesterday and the further 1% move overnight.  That very strong yen is clearly going to weigh on Japanese corporate profitability.  The other thing is that there is one country that is not all-in on the end of inflation, Norway.  This morning, in the wake of the Fed’s reversing course, the Norges Bank raisedrates by 25bps in a total surprise to the markets.  This has pushed the krone higher by a further 2.3% this morning and nearly 4% since the FOMC meeting.  

As we head toward the Christmas holidays and the beginning of a new year, it seems like the early going will be quite positive for risk assets and quite negative for the dollar.  Keep that in mind as you consider your hedging activities for 2024.

Good luck

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Now Estranged

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“Something appears to be giving”
Said Waller, the true cost of living
So, bonds rallied hard
The dollar was scarred
But stocks were quite unreactive-ing

The narrative clearly has changed
With hawks on the Fed now estranged
Is everything better?
As world’s largest debtor
We need low rates to be arranged

Fed Governor Chris Waller, one of the erstwhile hawks on the FOMC was covered in white feathers yesterday as he explained his latest perception that the Fed was on a path to achieving their 2% inflation goal as Q3’s expansive GDP was clearly an outlier and the data he cited showed economic growth slowing toward trend just below 2%.  The other Fed speakers on the day did not back him up specifically, and in fact, Governor Bowman explained her base case was the Fed needed to hike still further to be certain inflation was under control.  However, the market only had eyes for Waller and has heard the following message from the Fed, ‘we have finished hiking, and the next move will be a cut.’  Although this had been a building narrative, until yesterday there had been consistent pushback from virtually every Fed speaker with the higher for longer mantra.  However, the current belief set is that higher for longer has just been buried and that lower rates are in our future.  Let the celebrations begin because the Fed has achieved the much discussed, though rarely achieved, soft-landing.

However…it is still a bit premature, to my mind, to celebrate accordingly.  In fact, just yesterday the Case Shiller Home Price Index showed an annual rise of 3.9%, which although 0.1% less than forecast, also shows that the widely claimed decline in house prices due to higher yields, has not materialized.  And consider, if yields are set to go lower, the idea that house prices are going to fall and feed into lower inflation seems absurd unlikely.

But logic has never been an important part of any market narrative, and this time is no different.  The fact that declining bond yields (Treasuries fell 6bps yesterday and a further 5bps in the aftermarket) and the fact that the dollar, as measured by the DX, fell 0.5% led by USDJPY falling nearly 1.5% to its lowest level since September, has eased financial conditions thus supporting economic activity and inflation, is of no importance to the narrative.  Once again, we have heard from some big-name traders, Bill Ackman in this case, claiming that the Fed is now going to cut well before the market is pricing, predicting the first cut in March 2024. The market response to this has been for Fed funds futures to price a 40% chance of a March cut and a 75% chance of one at the May meeting.

And maybe all this is correct.  However, as I wrote yesterday, I believe that we are going to see a significant additional amount of federal government largesse to help prop up the economy, and that is not going to push inflationary pressures lower, the opposite in fact.  As is always the case, nothing matters until it matters, and right now, the only thing that matters is that the narrative is all-in on rate cuts coming soon to a screen near you.  While we could easily see further short-term weakness in equity markets as portfolios rebalance after a huge equity rally this month, it certainly seems like a push higher in risk assets is on the cards into Christmas.

As we consider the price action from yesterday and overnight, the thing that really stands out is that the US equity markets did so little on this very clear change in tone from a key Fed speaker.  Had you told me this was going to be Waller’s attitude prior to the session, I would have expected US equity markets to rally by 1+% each, with the NASDAQ really embracing the idea of lower rates.  But while the three major indices all closed in the green, it was only at the margin, +0.1% – +0.3% with a very late day rally.  Yes, futures are pointing higher this morning, up about 0.3% across the board, but again, this is somewhat unimpressive.  Perhaps the market has already priced in this idea, hence the 10% rally in November.

There is another wrinkle in this narrative as well, and that is that APAC shares are underperforming in both China and Japan.  Regarding the former, the Hang Seng (-2.0%) fell again as continuing concerns over Chinese corporate growth and profitability weigh on the index with Meituan reporting poor results.  On the mainland, despite hopes that the government was going to do more to support the property market, thus far it has been all talk, and no action and investors are getting tired of waiting.  Europe, however, is having a better go of it this morning, excluding the UK, where continental indices are all nicely higher, at least 0.5% with some as much as 0.9%.  

Not surprisingly, European debt markets are rallying as European sovereigns are following the US lead, ignoring the pleas from ECB speakers that higher for longer remains the path forward.  As such, we are seeing further declines on the order of 4bps – 6bps across the continent, matching US yield declines for the past two days.  Yields in Asia, though, are quite interesting with some very different narratives playing out there.  Starting with Japan, which saw yields fall 9bps last night, back to their lowest level since September, we heard from BOJ member Seiji Adachi that it was premature to consider exiting ultra-loose monetary policy amid global economic uncertainties and the end of the aggressive rate hikes in the US.  That seems counter to what had been the building narrative regarding Ueda-san’s next move.  Australia saw yields decline 14bps but in New Zealand, the decline was much more muted, just 2bps, after the RBNZ left rates on hold, as expected, but was far more hawkish in their statement than expected and hinted at potential further rate hikes.  

Turning to the commodity markets, oil continues to rebound, rallying another 1.8% this morning and recouping all its recent losses as confusion still reigns over the OPEC+ meeting tomorrow, or perhaps to be delayed again.  As well, it seems that a massive early winter storm closed ports in the Baltic and so oil shipments have been interrupted there for the time being.  Gold, though, has been the big story in commodity markets as it exploded higher yesterday after the Waller comments, jumping $30/0z (1.5%) to levels last seen in May and once again approaching its all-time highs of $2085/oz.  The market technicians are getting quite excited as they see a break there as having potential for a much larger run higher.  A case can be made that this is not a vote of confidence in the Fed’s anticipated future handling of inflation, but for now, we can simply attribute it to lower interest rates around the world.

Finally, the dollar has taken a straight-right to the chin and is reeling against virtually all its counterparts, both G10 and EMG. While we have seen a bit of a rebound this morning, since Monday’s close, EUR (+0.3%), GBP (+0.5%) and JPY (0.65%) have all rallied nicely, and that is after giving up some of those gains overnight.  We saw similar movement in the EMG bloc with CNY (+0.3%), PLN (+0.3%) and BRL (+0.8%) all responding positively to the Waller comments.  As I have been saying recently, if the Fed is truly done, then the dollar is likely to suffer, at least until such time as the other central banks fall in line.

On the data front, in addition to the Case Shiller Home Prices yesterday, we saw Richmond Fed Manufacturing which disappointed at -5.0 (exp 1.0), yet another sign that growth is waning.  It is data like this that has Waller in the mindset that slowing growth will lead to lower inflation.  Of course, rising home prices would certainly be a crimp in that theory.  Today we see the second look at Q3 GDP (exp 5.0%) with Real Consumer Spending expected at +4.0%.  We also get the Fed’s Beige Bok at 2:00pm and Cleveland Fed president Mester speaks at that time.  It will be interesting to hear if Mester, a very clear hawk, confirms the Waller thoughts or tries to push back alongside Governor Bowman.

For now, while the dollar has bounced slightly this morning, as long as the narrative remains the Fed is done and that cuts are coming soon, you have to believe the dollar is going to fall further from here.  If pressed, I would suggest USDJPY has the furthest to decline, but the fact that we have already had pushback from the BOJ implies that they are not that unhappy it remains weak.  After all, it supports their corporate sector and helps keep inflation higher, which remains one of their goals.

Good luck

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More Fun Than Blondes

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In just the past week we have seen
That traders have changed their routine
They’re confident bonds
Have more fun than blondes
‘Cause rate cuts are what they now glean

Despite this, most central bank threads
Explain rate cuts ain’t in their heads
They all still maintain
Inflation’s not slain
And so now, they’re at loggerheads

There is only one story that continues to drive market activity lately, and that is bond yields.  They have become the best barometer of market sentiment we’ve seen in quite a while and the reaction function is quite clear; lower yields mean a soft landing, is coming and with it, central bank rate cuts to prevent a hard one.  While the US continues to lead the way, we are seeing yields decline around the world.  In essence, the bond markets worldwide have declared victory on behalf of the central banks.  In fact, as I look at my screen this morning, of the major economies in the world, only two, Mexico and South Africa, have seen 10yr yields climb today and that has been by 1.5bps and 0.5bps respectively.  In other words, virtually unchanged, while the rest of the world has seen declines of between 3bps and 7bps with even JGB yields lower by 5bps.

There are more and more adherents to the soft landing story as recent inflation readings have been declining steadily while economic activity is not slipping nearly as quickly.  Of course, this view is not universal as there remains a camp that points to underlying pieces of the economic puzzle like slowing bank lending growth or sliding manufacturing and are still looking for a more dramatic downturn in economic activity.  But generally, between the cheerleaders in finance ministries around the world and CNBC talking heads, all is right with the world.

Of course, if you are a central banker right now, all this positivity is working at cross purposes to your view that inflation is not actually dead and there is still further to go.  This is why we continue to hear that although progress has been made, it’s too early to take the victory lap.  We heard it from Cleveland Fed President Loretta Mester yesterday and from Austrian Central Bank chief and ECB Council Member Robert Holzmann this morning.  And we have been hearing it consistently for the past week, policy is somewhat restrictive, but we need to stay here until we are sure inflation is heading back to target.

Now, I am old enough to remember when the idea of tighter financial conditions doing the Fed’s job for them was a thing.  But in the month that has passed since that was first mooted, financial conditions are actually looser now than then.  The point is that the feedback loop between the data and the market response is now so dramatic, and occurring so rapidly, that the central bank reaction function is falling further behind the curve.  I have neither heard nor read a single thing in the past several days that implies there is a possibility the central banks are not done.  

But whether more rate hikes will do anything for inflation is no longer the issue, my sense is central banks want to make sure they are seen as in control.  I know things have been great lately with equities and bonds on fire and everybody’s 401Ks growing, but Jay doesn’t really care about your portfolio, and absent a complete collapse in economic activity in the next month, I would not be surprised by a December rate hike.  There is clearly no certainty on this, and the Fed funds futures market is currently pricing in just a 0.3% chance of it occurring.  I also know the Fed does not like to surprise markets, but I think the Fed fears the appearance of losing control more than anything else.  

However, until such time as they sound increasingly forceful, or the data starts to show inflation is not collapsing, it is hard to fight this move.  We have come a very long way in a very short period of time with respect to 10-year Treasury yields, a 60 basis point decline in slightly less than a month.  Be careful in assuming this will continue in a straight line.  As well, the fact that the yield curve’s inversion remains at -40bps is quite interesting.  Given the market is pricing 100bps of rate cuts by the end of 2024, I would have expected the front end of the curve to have fallen further in yield.

But that is where things stand as we get ready for another weekend and then, next week’s Thanksgiving holiday.  So, a quick tour of the overnight session shows that Chinese equities remain under pressure, especially in Hong Kong (-2.1%) as whatever they are doing over there is not solving their problems.  However, Japan is benefitting with modest gains and Europe is higher this morning across the board, about +0.8%.  As well, after a mixed day yesterday, US futures are pointing slightly higher, +0.2% or so at this hour (8:30).

We know the bond story so a look at commodities shows oil bouncing a bit, +1.3%, although it has been a horrific week and month for the black sticky stuff, down -15% in the past month.  Gold and silver, however, are huge beneficiaries of the decline in yields as they continue to rally and base metals are holding their own as well on the softer yield story.

Finally, it should be no surprise that the dollar remains under pressure, down 0.2% broadly (the DXY).  In the G10, JPY (+0.85%) is the leader followed by AUD (+0.5%) but all of them are firmer.  While there is a little more divergence in the EMG bloc, the broad trend remains for a softer dollar and as long as US yields remain under pressure, the dollar is likely to do so as well.  The one place I would watch carefully is the yen, as there is a growing belief it is set to rebound sharply.  On the plus side is the fact that US yields are falling, and the rate narrative is changing rapidly.  But remember, Japanese yields are also declining, and their recent GDP data was terrible, -2.1% in Q3, so the idea that the BOJ is going to tighten policy soon seems shaky at best.  There are many technical support levels on the way down, but do not be surprised of a test of 142.00 in the coming weeks if the current zeitgeist continues.

On the data front, Housing Starts (1.372M) and Building Permits (1.487M) were both released this morning pretty much on target and put paid to the idea that the housing market is collapsing. For the rest of the day, we have 5 more Fed speakers, but I doubt we hear anything new.  One other thing to remember is that Sunday, Argentina goes to the polls and the chances for the upstart candidate, Javier Milei, seem pretty good as the people there are fed up with the current government.  That could have some repercussions both financially and politically around the world, especially the latter, as it would be another step away from the current ruling class.  The point is, I do not believe that everything is better, and while right now things look good, there is more volatility in store.  Be careful and stay hedged, it is your best protection.

Good luck and good weekend

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Markets No Longer Have Fear

Posted on by 
The CPI data made clear
That markets no longer have fear
But Jay and his team
Will still push the theme
That cuts in Fed funds just ain’t near

As such markets have been persuaded
It’s time for the Fed to be faded
The bulls are on top
And they just won’t stop
Til new record highs have been traded

By now, you are all well aware that yesterday’s CPI data came in a bit softer than the forecasts with the headline printing at 3.2% Y/Y while the core printed at 4.0% Y/Y.  Both of these were 0.1% lower which doesn’t seem to be that big a difference.  But the bulls are stampeding on the idea that if you look at the recent trend, the annualized rate for the past 6 months is lower still (3.0% and 3.1% respectively) and the implication is that inflation is dead and the Fed has achieved the impossible, reducing inflation without causing a recession.  And maybe they have, but boy, that is a lot to take away from a single data point that printed a smidge lower than expectations.

Two weeks ago, in the wake of the last FOMC meeting, I wrote (Bulls’ Fondest Dreams) that the Fed changed their tune and despite all the pushback we have received from Fed speakers in the interim, they definitely saw the end of the hiking path coming into view.  Yesterday’s data seemed to confirm this view, at least in the markets’ eyes.  As such, we saw a massive rally in both stocks and bonds, with 10-year yields falling 20 basis points at one point in the day before closing lower by about 17bps.  They are 2bps higher this morning on the bounce.  Interestingly, European sovereign yields also fell quite sharply despite the lack of local news as the price action once again proved that the 10yr Treasury yield is the only bond price that really matters in the world.

So, to me the question is now, is this view correct?  Has the Fed actually threaded the needle and successfully reduced inflationary pressures without causing a meaningful economic slowdown?  If so, Chairman Powell will rightly be hailed as a brilliant central banker, even if there was some luck involved.  How can we know, and more importantly, when will we be certain this is the case?

I think it is important to try to separate the markets and the economy as the two are really quite different.  The economy is where we all live.  From an individual perspective, I would contend it is a combination of one’s employment situation(and whether there is concern over losing one’s job or finding a new one), the true cost of living, meaning the ability to afford the mortgage/rent as well as put food on the table, and then to see if there is any additional money left to either save or spend on desires rather than necessities.  It seems abundantly clear that from this perspective, there is a large segment of the population that doesn’t feel great about things.  This was made clear in an FT survey that showed just 14% of those surveyed thought things had gotten better economically under the Biden Administration’s policies.

However, if this poet has learned nothing else in his time trading in, and observing, financial markets, it is that policymakers do not care one whit about those issues.  Despite periodic attempts to seem down-to-earth, the reality is they all exist within a policy bubble with no concerns about the rent or their next meal.  In this bubble exist only numbers like yesterday’s CPI or today’s Retail Sales (exp -0.3% headline, 0.0% ex autos).  GDP, to them, is not a measure of people’s confidence or belief in the state of the current world, it is a policy variable that they are trying to manage or manipulate so they can make positive pronouncements.

There is obviously quite a gulf between those two views of the world and the markets are the connection, trying to interpret the reality on the ground through the lens of the data.  Well, the policymakers must be thrilled today because the extraordinary bullishness that is now evident across all risk markets, in their minds, means that their jobs are secure.  When things are going well, reelection/reappointment are the expected outcomes.  However, that FT survey was clearly a warning shot across the bow of their Good Ship Lollipop that everything was going to be great going forward.

So, what’s it going to be?  As I wrote after the FOMC meeting, I believe the market is prepped to rally through the rest of the year.  After yesterday’s data, that seems even clearer.  But do not forget that one of the key rationales for the Fed’s change of heart was that the market was doing the Fed’s work for them, tightening policy by raising rates and watching risk assets drift lower, thus tightening financial conditions.  Let me tell you, financial conditions loosened a lot yesterday, and if this rally continues, you can be certain that Powell and friends will grow more concerned about a rebound in inflation.  The market has completely removed any probability of a December rate hike, or any further rate hikes by the Fed as of yesterday with the first cut now priced for May 2024.  At this stage, it seems probable that the October PCE data will be on the soft side so much will depend on the next NFP and CPI readings, both of which are released before the next FOMC meeting.

And there is one more thing that must be remembered when it comes to the bond market.  The US is still going to issue an enormous amount of debt going forward between refinancing ($8.3 trillion though 2024) the current debt and the new $2 trillion budget deficit that needs to be funded for next year.  Can bonds continue to rally in the face of that much supply?  Maybe they can, but it would seem to require a reengagement of foreign buyers rather than relying entirely on domestic savers.  Either that or the Fed will need to end QT and possibly even restart QE.  In the latter case, inflation would almost certainly become a major issue again.  The point is, while everyone is feeling great this morning, there are still numerous perils to be navigated in order to maintain economic growth with a low inflation regime.  I hope Jay and all the central bankers are up to the task, but a little skepticism seems in order.

Ok, the overnight session can be summed up in one word: BUY!  Equity markets everywhere rallied with strong gains in Asia (Hang Seng +3.9%) and Europe, after rallying yesterday, continuing higher by nearly 1% this morning.  US futures are also all green this morning, generally +0.5% at this hour (7:30).

Bond markets have mostly held onto yesterday’s impressive gains with some trading activity, but movements all within a basis point or two from yesterday’s close.  The exception was Asian government bond markets, where prices rallied sharply, and yields tumbled there as well, following the US lead.

Metals prices are ripping higher again this morning, with gold, silver, and copper all up nicely after strong gains yesterday.  The outlier here is oil, which is a touch lower (-0.4%) this morning after a very lackluster session yesterday.  Now, in fairness, it has been creeping higher for the past several sessions, but compared to other markets, oil is remarkably quiet right now.

Finally, the dollar got smoked yesterday, with the euro rallying 1.5% and similar moves across the other European currencies.  Meanwhile, AUD rallied more than 2% yesterday as the combination of rocketing metals prices and a broadly weaker dollar were just the ticket for the currency.  In the EMG bloc, ZAR (+3.0%) and MXN (+1.5%) were the big winners yesterday although, interestingly, most of the APAC currencies had much more muted runs, on the order of 0.5%-1.0% gains.  This morning, price activity is much more subdued as FX traders are trying to get their bearings again.  It was, however, a 3-sigma day, a rare occurrence.

On the data front, as well as Retail Sales, we also see PPI (exp 2.2% headline, 2.7% ex food & energy) and the Empire Manufacturing Survey (-2.8) along with EIA oil information where inventory builds are forecast.  There is only one Fed speaker, vice chairman of supervision Michael Barr, and I don’t expect he will be able to sway any views today.

For now, the die is cast, and the bulls are in the ascendancy.  We will need to see some very big changes in the data trajectory for the current momentum to stall, and quite frankly, I don’t see what that will be for now.  So, go with the flow here, higher stocks, lower yields and a softer dollar seem to be the trend for now.  There will be some trading back and forth, but you can’t fight City Hall.

Good luck

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No Longer a Threat

Posted on by 
Opinions are already set
The Fed is no longer a threat
Today’s NFP
Will help all to see
That buying stocks is the best bet

At least that’s the narrative tale
The talking heads want to prevail
The question’s, will Jay
Have something to say
If finance conditions, up, scale

To conclude what has already been a tumultuous week, this morning brings the monthly payroll report, a key piece of evidence for the Fed to determine the health of the economy.  Expectations for the readings are as follows:

Nonfarm Payrolls180K
Private Payrolls158K
Manufacturing Payrolls-10K
Unemployment Rate3.8%
Average Hourly Earnings0.3% (4.0% Y/Y)
Average Weekly Hours34.4
ISM Services53.0

Source: tradingeconomics.com

Apparently, the whisper number is a bit above 200K, but we also must pay close attention to the revisions.  Recall last month had a blowout 336K result, which was much larger than expected.  If that number retains its strength, it would certainly be indicative of a still healthy labor market.  This matters a great deal as after Powell’s press conference on Wednesday and the surprising QRA that shortened the duration of upcoming Treasury bond issuance, the market is all in on the goldilocks story, solid growth with low inflation.  The corollary to this is that the market is looking for the Fed to back off the current rate policy and begin to reduce the Fed funds rate, thus helping all the DCF models pump up the value of equities.

But even though I have been highlighting the importance of the NFP number for the past two years as a key for the FOMC, it is not clear to me that today’s is so important.  I only say this because the Fed just met two days ago, and we will see another NFP before they meet again.  Arguably, this one will get lost in the fog of memory.  

If that is the case, then it is probably a good time to recap what we have seen this week and how it has affected market sentiment.  The bulls are on a roll right now as we have seen a significant pullback in Treasury yields with 10yr down to 4.66%, down 36bps from their peak back on October 23rd.  While that is certainly a large move in a short period of time, it is in line with the types of movement we have been seeing all year, so hardly unprecedented.  But Powell’s comments, which have been read as dovish despite his best efforts to prevent that view, and the bond market movement have many market participants licking their chops for a massive equity rally going forward.

Interestingly, one of the things the talking heads have been using to pump their story has been the tightening in financial conditions that were a result of declining stock and bond prices.  The whole issue of tighter financial conditions doing the Fed’s work for them has been a key story for the past several weeks since it was first mentioned by Dallas Fed President Lorrie Logan.  However, the big rally in both stocks and bonds, as well as the decline in the dollar, are all critical features in the calculation of those financial conditions, and they are all pointing to easier conditions.  The point is, if tighter conditions was a reason for the Fed to have stopped tightening further, the fact that they are now easing implies the Fed may feel the need to raise rates again in December, although that is clearly not the consensus view.

At any rate, right now, momentum is on the bulls’ side, and it is tough to overcome.  Certainly, the economic data continues to point to a resilient economy which implies, to me at least, that the Fed will not feel any urgency to cut rates soon.  There has also been a great deal of discussion regarding the fact that the average time the Fed has held rates at a peak before cutting is just 7 months.  We are now three months into the most recent hold, and, by definition, since the next meeting is not until December, we will be at 5 months then.  My observation about Chairman Powell, though, is at this point he is unconcerned with statistics of that nature and is far more focused on achieving their objective of 2% inflation.  

One last thing about inflation before we touch on markets.  There has been a growing chorus that deflation is on its way because M2 money supply growth is currently declining.  However, for the economics majors out there, recall that the key monetary equation is M*V = P*Q.  P = prices, and Q = quantity of goods, or, combined economic output.  M = Money supply and V = Velocity of money.  It is the last piece that is often ignored but remains quite important.  My good friend @inflation_guy, has just published a piece which is well worth reading.  The essence is that while M2 may be declining, V is rising rapidly, offsetting that impact and creating conditions for much stickier inflation than many believe.  I have a feeling the Fed is going to stay on hold, if not tighten further, for a much longer time than currently anticipated.  While this week’s news has clearly been seen as bullish, the long-term trends have not yet changed in my view.

Ok, so a quick look at markets shows that after another gangbusters day in the US, where all three major indices were higher by 1.7% or more, Asian markets followed suit, with virtually every index there higher by at least 1.0%.  Europe, however, has been more circumspect with markets essentially unchanged this morning, just +/- 0.1% on the day.  US futures are ever so slightly softer at this hour (7:30) down about -0.15% on average, as investors and traders await this morning’s data.

At this point, bonds seem to be taking a rest after a huge price rally / yield decline over the past several sessions and we are seeing very little movement on the day with Treasuries and European sovereigns all within 1 basis point of yesterday’s closing.  Even JGB yields slid a bit yesterday but remain above 0.90% as of now.  As to the shape of the yield curve, that inversion is starting to show its head again, with the current 2yr-10yr spread back to -32bps.  Remember, two days ago that was at -18bps.  Broadly speaking, yield curve inversions are not signs of economic strength.

In the commodity space, oil is creeping back higher, up 0.4% this morning although still lower on the week.  Gold is basically unchanged this morning, continuing to hang out just below $2000/oz, which continues to surprise me given the sharp decline in yields, at least nominal yields.  As to the rest of the space, base metals are mixed amid small changes this morning and foodstuffs, something I have not mentioned in a while, have actually been declining with the FAO’s world food price index falling to its lowest level in more than 2 years last month.  It may not seem that way in the grocery store, but perhaps future price rises will be more muted.

Finally, the dollar is generally biding its time ahead of the data, although leaning lower overall.  In the G10, the average gain of a currency is about 0.2% while in the EMG bloc we have seen a few outliers, notably KRW (+1.2%) but a more general rise of 0.4% or so.  You already know that my view has changed given the seeming change in the underlying drivers.  For now, and likely through the end of the year at least, I think the dollar will be under pressure.

Aside from the data this morning, we get our first Fed speaker, Supervision Vice-Chair Michael Barr, this afternoon, but the topic is the Community Reinvestment Act, which makes it unlikely he will swerve into monetary policy.  So, as is often the case, the data will see a flurry of activity at 8:30 and then I suspect the recent trends will reassert themselves in a slower session overall.  We will need to see an extraordinarily strong NFP print to help reverse the dollar’s current malaise.

Good luck and good weekend

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Bulls’ Fondest Dreams

Posted on by 
While everyone focused on Jay
The earlier news of the day
Showed Janet would not
The long bond, allot,
Too much, thus yields faded away

Combining that news with the Fed
And all of the things that Jay said
It certainly seems
The bulls’ fondest dreams
Are likely to still be ahead

While most of the headlines yesterday afternoon and this morning revolve around the FOMC meeting and, more importantly, Powell’s press conference, I would argue that as I discussed yesterday, the biggest story was the QRA early in the morning.  Historically, the Treasury has tried to keep T-Bill issuance between 15% and 20% of total Treasury issuance.  However, a look at the current mix shows that Secretary Yellen already has that ratio up to 22.6%.  One of the big questions was how that would play out going forward.

Recall, one of the narratives that has been invoked for the Treasury bond sell-off with corresponding rising yields, has been the supply story.  You know, the US is running massive budget deficits and needs to issue more debt to fund it, so there is a lot more supply coming.  A key assumption in this story was that the mix of debt, which already favored T-Bills, would not change much so the new debt would be forced into the back end of the curve.  Well, that’s not how things worked.  The QRA indicated that the Treasury was going to issue a lot more T-Bills, a total of $1.1 trillion over the next two quarters, raising the proportion of T-Bills to 23.2%, even further above the old ceiling.  Of course, the result is much less issuance in the 5yr and longer space, thus undercutting the excess supply argument.

The results cannot be surprising as even before Powell started speaking, 10-year yields had fallen 11bps although they continued to decline afterwards as well, finishing the day lower by 16bps or so.  All in all, an impressive bond rally.  But let’s consider for a moment a different consequence of yesterday’s announcements, the shape of the yield curve.  Prior to the QRA and the Fed, the yield curve, as measured by the 2yr-10yr spread had fallen from a low of -108bps to just -15bps and it seemed almost certain that it would normalize soon.  However, now that the QRA has shown there will be more issuance out to 2yrs and less beyond, the immediate impact is the curve is going to go back to inverting further, (it is already back to -22bps) at least until such time as the Fed actually does cut rates.  I have a feeling that we are going to hear a lot more about recession again even though Powell explicitly said the Fed was not expecting one.  In fact, Powell and the Fed may be the only people not expecting a recession at this point!

A quick look at the Fed funds futures market shows that for the December FOMC meeting, the market is currently pricing a 20% probability of a 25bp rate hike.  That is slightly lower than before the FOMC meeting yesterday, but within the margin of error.  However, at this point, the market has a 43% probability of a rate cut in May, with that probability growing as you head out further in time.  One of the things Powell reiterated yesterday is that the committee is not even discussing the idea of a rate cut.  Of course, he also said that they don’t believe a recession is coming so it is not surprising the market has a different rate view than the Fed.

In the end, I think this is a seminal shift in policy with the combination of Treasury and Fed actions indicative of a much easier policy stance going forward.  I have built my views based on the Fed maintaining its higher for longer stance and continuing to stress the system which remains massively leveraged.  However, if he is no longer going to follow that path, and I think we learned yesterday that the inflection point is here, then we need to rethink the future.  One consequence of this policy change, though, is that inflation, which I have maintained is going to remain far stickier than many anticipate, is going to become an even bigger problem down the road.  I just don’t know how far down the road that will be.  But for now, I think we are going to continue to see equities rebound into year end, bond yields fall, the dollar fall, and commodity prices rebound.  This is going to be a classic risk-on scenario through the end of the year in my view.

And despite, or perhaps because of, continued weaker data, that is what we are seeing in markets around the world.  Yesterday’s ISM Manufacturing data was quite soft at 46.7, and this morning the PMI data from the rest of the world was generally awful with all European readings between 40 and 45.  Yesterday’s ADP Employment data was soft, at 113K which just added fuel to the policy easing fire and though the JOLTS Job Openings data was still strong, the net perception is slower times are ahead, and with them, lower interest rates.

A look around markets shows that after yesterday’s US rally, with the NASDAQ leading the way higher by 1.6%, Asian shares rallied (Nikkei +1.1%, Hang Seng +0.75%) and we are seeing strength across the board in Europe with all major indices higher by at least 1.25%.  And don’t worry, US futures are pushing higher again, up about 0.5% at this hour (7:15).

It is, of course, no surprise that bond yields around the world are lower with European sovereigns declining by between 7bps and 12bps after both Australia and New Zealand saw yields tumble 16pbs and 25bps respectively.  Even JGB yields are softer by 3bps.  In fact, Dutch central bank president Klaas Knot, one of the most hawkish ECB members, is on the tape this morning with the following quote, “We should be a little patient and not raise rates too much.”  That may be the most dovish thing he has ever said.  The point here is that until such time as inflation really comes roaring back (and I fear that day will come), the direction of travel in interest rates is lower.

Oil prices, which remained under some pressure in the past week, have bounced 1.4% this morning with the movement seeming to be a response to the policy changes while gold (+0.3%) is also climbing, although a bit slower than I might have expected.  But we are seeing strength throughout the commodity complex on the lower rate story with copper (+0.5%) rallying despite the prospects of a recession.

Finally, the dollar is under pressure across the board with the DXY down -0.7% led by the euro (+0.6%), AUD (+0.7%) and NZD (+0.95%).  The yen (+0.4%) is a bit of a laggard today, though remains above the 150 level, but I suspect that we are going to see dollar weakness continue going forward.  Against EMG currencies, we are also looking at a weaker greenback with KRW (+1.0%) leading the way, but strength through APAC and EEMEA and MXN (+0.6%) firmer as the only representative of LATAM that is trading at this hour.  Yesterday Banco Central do Brazil cut their SELIC rate by 50bps to 12.25% as widely expected and BRL rallied 2% on the day.  Again, the theme is now a weaker dollar going forward.

To show how big a deal yesterday was, the BOE meets this morning, and nobody is even discussing it.  Expectations are for no policy change, although perhaps given the sudden dovishness breaking out worldwide, they will consider a cut!  We also see a bunch of US data as follows: Initial Claims (exp 210K), Continuing Claims (1800K), Nonfarm Productivity (4.1%), Unit Labor Costs (0.7%) and Factory Orders (2.4%).   There are no Fed speakers on the schedule today, but they get started again tomorrow.  Remember, tomorrow we also see NFP, so still some fireworks potentially.

For now, though, the new trend is risk on, dollar down.  

Good luck

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Three Extra Trill

Posted on by 
Said Goolsbee, I’m, processing, still
Why bond yields keep moving uphill
Perhaps he should look
At Yellen’s full book
Of issuance, three extra trill

So, with the third quarter now ending
And core PCE, today, pending
The hope and the dream
Is next quarter’s theme
Will be ‘bout risk assets ascending

In a speech yesterday at the Peterson Institute for International Economics, Chicago Fed President Austan Goolsbee laid out his current views on the US economic situation, which he thought was generally in good shape, and warned about overtightening.  He also noted the Fed has a rare opportunity to achieve a soft landing.  All that is ordinary enough.  The odd comment came when he mentioned that he was “still processing’ why bond yields were rising so much recently.  It is always disconcerting to me when the so-called best and brightest who lead our key institutions expose themselves as being clueless in their main role.  

As I have discussed in the past, it is not very difficult to determine why long-term yields are rising in the US, it is a combination of two absolutes and one likelihood.  The absolutes are the amount of supply hitting the market and the reduced demand.  Treasury Secretary Yellen has indicated in Q4 there will be new issuance of ~$852 billion on top of current refinancing of >$1.3 trillion, hitting the market.  At the same time, the Fed continues its QT program reducing demand by $180 billion in Q4 and both China and Japan, the two largest holders of Treasuries have been slowly reducing their positions.  The point is excess supply and reduced demand will drive prices lower.  The likelihood is that the private sector that will be required to purchase these bonds is wary of inflation rebounding on the back of higher energy prices and increasing wage costs (between the UAW strike and the latest law in California that mandates a $20/hour minimum wage for fast food workers, wages seem set to rise further still), and so are demanding to be paid more to buy the paper.  It is not really that complex.

Yesterday, after printing at 4.68%, a new high for the move, the 10-year yield fell back a bit, which is much more about market technicals and an oversold condition rather than a change in the underlying issues discussed above.  This morning, that yield is lower still, but just by 2bps and currently trading at 4.55%.  Of equal interest is the fact that the yield curve continues to bear steepen with the 2yr-10yr curve inversion now down to -50bps.  While we are likely to see a little trading bounce, this trend remains clear, and the fundamentals support higher yields.  I expect the 10-year yield to reach 5% by the end of 2023 and somewhere between 5.5% and 6.0% by the election next year.

If we look elsewhere in the world, we are seeing yields rise right alongside Treasury yields.  Perhaps the only place that is lagging is Japan, where the BOJ executed an unscheduled JGB buying operation last night of¥300 billion to help moderate recent movement.  This was interesting given the data out of Japan last night, notably weaker Retail Sales and a lower-than-expected Tokyo CPI at 2.8% (2.5% core) implies that the BOJ is not likely to feel much pressure to tighten.  With the Fed still all-in on higher for longer and the BOJ able to point to softening inflation as a reason to continue QE and loose policy, USDJPY will continue to be the outlet valve in the economy, and it should rise (yen weaken) still further.

Meanwhile, the most important spread in Europe, the bund-BTP spread in the 10-year space is back to 200bps.  This is the level at which the ECB has demonstrated concern in the past and I am confident that there is much discussion ongoing today.  We did hear from one of the ECB hawks overnight, Nagel, who was clear that another rate hike might be appropriate, but I assure you, if that spread widens much further, rate hikes are not going to be the ECB’s approach.  All in all, we are likely to see much future stress in bond markets.  And to think, none of this even touches on the potential government shutdown tomorrow!

And yet, equity markets bounced yesterday into month/quarter end and European bourses and US futures are all in the green today as the bulls are now telling us that things are oversold, and a rip-roaring rally is imminent.  Clearly, we have seen some pretty weak behavior in the risk asset space lately and a technical bounce is not surprising.  However, it remains very difficult for me to see the upside for stocks as long as bond yields are rising along with oil and inflation remains sticky.  Too, the dollar, while it also reversed course yesterday after a remarkable run higher over the past two plus months, is still quite firm overall, and as long as US yields rise, I look for the dollar to follow.

On the lighter side, the best non-sequitur correlation I have seen is that Top Gun was released in May 1986 and Black Monday, which saw the largest equity market selloff in history occurred in October 1987.  Well, Top Gun II was released in May 2022.  Should we be looking for a massive market decline in the next two weeks?  The starting conditions are not actually that different with an overvalued stock market, rising rates, rising oil prices and a rising dollar.  Just sayin!

As we look to the calendar today, the Core PCE data is set to be released at 8:30 and expected at 0.2% M/M, 3.9% Y/Y.  Many analysts continue to use the concept of annualizing last month’s data and pointing to the Fed achieving its target, or excluding the rise in prices of certain segments beyond food and energy and claiming not only is inflation falling, but deflation is coming.  Clearly, if you exclude the prices that are rising in the index, then the index will demonstrate falling prices, however it is not clear to me what that tells us.  We also get the Goods Trade Balance (exp -$95.0B), that excludes services, and we see Chicago PMI (47.6) and Michigan Sentiment (67.7).  Yesterday’s GDP data was a touch softer than expected at 2.1% with the most concerning part that Real Consumer Spending rose only 0.8% Q/Q, half the level of forecasts and down from 3.8% in Q1. On the flipside, Initial Claims fell to 204K, back to levels seen in January, and certainly no indication of economic weakness.

And that’s how we are heading into the weekend.  While yesterday saw trading reversals of the recent trends, there is no indication that those trends have ended.  The reversal and consolidation may last through today’s quarter end trading and into early next week but look for the longer term trends of a higher dollar, higher bond yields, higher oil prices and lower risk asset prices to resume before too long.

Good luck and good weekend

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Goldilocks Dream

Posted on by 
It seems many thought the word ‘could’
Was feeble when posed against ‘would’
The fact Chairman Jay
Had phrased things that way
Last month, for the bulls, is all good

And so, the new narrative theme
Is Jay is convincing his team
No more hikes are needed
And they have succeeded
In reaching the Goldilocks dream

The following quote from a weekend WSJ article by Fed whisperer Nick Timiraos is almost laughable in my mind.  

            This is apparent from how Fed Chair Jerome Powell recently described the risk that firmer-than-expected economic activity would slow recent progress on inflation. Last month, he twice used the word “could” instead of the more muscular “would” to describe whether the Fed would tighten again.Evidence of stronger growth “could put further progress at risk and could warrant further tightening of monetary policy,” he said in Jackson Hole, Wyo.

Talk about parsing language to the nth degree!  I bolded the line that I found the most ridiculous, but as we all know, my view does not drive the markets nor policy.  However, as I had written last week, we have definitely seen a shift amongst some of the FOMC members with respect to the idea of another rate hike this year.  Timiraos is widely believed to have the inside track to Chairman Powell, and now that the FOMC is in their quiet period ahead of the September 20th meeting, this will be the mode of communication.  

I guess the big risk of going all in on the Fed is done is we are still awaiting CPI Wednesday morning and with energy prices continuing to climb, I fear the opportunity for a high surprise is very real.  Literally every story that is written in the mainstream media these days tries to talk up the prospects of the economy and, correspondingly, for further equity market gains.  To me, there is a lot of whistling past the graveyard here, but so far, equities have held in despite some weaker data.  The one thing I would highlight is the market feels quite complacent with implied volatility across numerous markets, stocks, bonds, commodities and FX, all quite low.  Hedge protection is cheap here, if you need to hedge something, don’t wait for the move.

Ueda explained
We may soon understand if
Inflation is back

“If we judge that Japan can achieve its inflation target even after ending negative rates, we’ll do so,” said Ueda.  This was the key sentence in a weekend interview published last night.  The market response was immediate with the yen jumping more than 1% in the early hours of Asian trading before ceding a large portion of those gains when Europe walked in the door.  However, regardless of today’s price action, there is a longer-term signal here that is important to understand.  It has become clear that the BOJ is becoming somewhat uncomfortable with the speed of the yen’s decline.  Prior to last night’s session, the yen had fallen 7.75% from July’s levels, which is a pretty big move for less than 2 months.  There is no secret to why the yen continues to decline, the vast policy differences between the US and Japan are sufficient reason.  While Ueda-san made no promises, this was very clearly a signal that a change is coming soon.  In the near-term, hedgers need to be very careful and those who are hedging JPY assets or revenues should really consider buying JPY puts outright or via collars as there is every reason to believe that further yen strength is coming by the end of the year.

Meanwhile, on the western edge of the Yellow Sea, the PBOC was quite vocal last night as well.  On the back of Chinese monetary data that showed a larger rebound than forecast in New Loan data as well as Aggregate Financing data, the PBOC issued the following statement, “Participants of the foreign exchange market should voluntarily maintain a stable market.  They should resolutely avoid behaviors that disturb market orders such as conducting speculative trades.”  That is very clear language that the PBOC is unhappy with the recent CNY performance.  In addition, the PBOC issued new regulations regarding large purchases of dollars telling banks that any corporate client that wants to purchase more than $50 million will need to get approval to do so, and that approval will take quite some time to be forthcoming.

It should be no surprise that the renminbi is stronger this morning, having rallied 0.65% and thus closing the gap with the CFETS fix for the first time in months.  Of course, given the double whammy of Japanese and Chinese policy implications, it should be no surprise that the dollar is softer overall.  Especially when considering the WSJ article explaining that the Fed may be finished hiking rates.  So, we have seen the dollar fall against all its counterparts in the G10 and most in the EMG blocs.  Aside from the yen (+0.65%), we have seen the most strength in AUD (+0.8%) which has benefitted from the overall Chinese story, both the currency issues and the better data, as well as the rise in commodity prices.  Kiwi (+0.55%) and SEK (+0.45%) are next on the list as there is broad-based dollar weakness today after an eight-week run higher.

In the emerging markets, ZAR (+1.1%) is actually the best performer on the commodity story as well as the general dollar weakness, but after that and CNY, HUF (+0.6%) is the only other currency in the bloc with substantial gains.  The story here is what appears to be a shift from zloty to forint as the market continues to punish PLN (-0.35%) after the surprisingly large rate cut last week by the central bank there.  Net, however, the dollar is clearly under pressure this morning.

If we turn to other markets, though, things don’t seem to make as much sense.  For instance, oil prices (-0.4%) are a bit softer while metals prices (AU +0.4%, CU +1.7%, AL +1.0%) are all firmer.  Now, the metals seem to be behaving well on the back of the dollar’s weakness, but oil’s decline is not consistent with that view.

In the equity markets, last night saw a mixed picture in Asia with the Nikkei (-0.4%) and Hang Seng (-0.6%) both under pressure while the CSI 300 (+0.75%) and ASX 200 (+0.5%) both responded well to the news.  For the Nikkei, the combination of prospects of higher rates and a stronger yen are both negative for Japanese stocks, while much of the rest of APAC benefitted from the Chinese story.  In Europe, the bourses are all green, averaging about +0.5% as investors continue to believe the ECB is done hiking rates with the market now pricing less than a 40% probability of a hike this week and not even one full hike priced into the curve over time.  US futures are also green as investors embrace the WSJ article’s hints that the Fed is done.

Finally, the big conundrum is the bond market, which is selling off across the board.  Or perhaps it is not such a conundrum.  If both the Fed and ECB are done hiking despite inflation continuing at a pace far above target, then the attractiveness of holding duration wanes dramatically.  Add to that the gargantuan amount of debt yet to be issued and the fact that the biggest buyers of the past decades, China and Japan, seem to be backing away from the market, and it will require much higher yields for these issues to clear.  Of course, one could also look at this as a risk-on session with stocks higher and bonds getting sold along with the dollar, so perhaps that is today’s explanation.  Just beware the movement here.  10-Year Treasury yields (+3bps) are back to 4.30%, and if the story is no more Fed tightening thus higher inflation, that is unlikely to be a long-term positive for equities.  At least that’s what history has shown.

On the data front, the back half of the week brings the interesting stuff.

TuesdayNFIB Small Biz Optimism91.5
WednesdayCPI0.6% (3.6% Y/Y)
 -ex food & energy0.2% (4.3% Y/Y)
ThursdayECB Rate Decision3.75% (current 3.75%)
 Initial Claims227K
 Continuing Claims1695K
 Retail Sales0.1%
 -ex autos0.4%
 PPI0.4% (1.3% Y/Y)
 -ex food & energy0.2% (2.2% Y/Y)
FridayEmpire Manufacturing-10.0
 IP0.1%
 Capacity Utilization79.3%
 Michigan Sentiment69.2

Source: Bloomberg

As we are in the Fed quiet period, there will be no Fedspeak, so it is all about the data this week.  Beware a hot CPI print as that will pressure the narrative of the soft landing.  This poet’s view is no soft landing is coming, rather a much harder one is in our future, but at this point, probably not until early next year.  Until then, and despite today’s news cycle, I still think the dollar is best placed to rally not fall.

Good luck

Adf