Tag Archives: #skip

Views Will Be Tested

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When looking ahead to this week
With data and central bank speak
Some views will be tested
And some have suggested
The market is reaching its peak

But there is a growing belief
The future (that’s AI in brief)
Is shiny and bright
And stocks will take flight
Beware though, it could lead to grief

First a correction to Friday’s note regarding the blip lower in oil prices.  It was not inventory data but a story on a relatively obscure website, Middle East Eye, (h/t @inflation_guy) that discussed a seeming breakthrough in US-Iran talks that would allow Iran to export up to 1 million bbl/day in exchange for an agreement to slow their Uranium processing.  However, the story was vehemently denied by both the Iranians and the US and has been consistently denied since then by both sides repeatedly.  Now, I am of two minds on this story as denials of this extremity tend to point to some reality underlying the situation, but politically it would seem very difficult for the Biden administration to be seen to be negotiating with Iran heading into an election.  Regardless of the driver though, oil (-2.2%) is falling sharply again today with WTI below $69/bbl now.  This continues to point to the dichotomy of commodity markets sensing significant global slowing in growth while the equity markets see the world growing gangbusters.  Both sides cannot be correct, so at least one set of markets will need to adjust going forward.

 

Meanwhile, after an extremely lackluster week regarding new information, this week is exactly the opposite with critical data points like CPI as well as three major central bank meetings, Fed, ECB and BOJ.

 

Tuesday

NFIB Small Biz Optimism

88.4

 

CPI

0.2% (4.1% Y/Y)

 

-ex food & energy

0.4% (5.2% Y/Y)

Wednesday

PPI

-0.1% (1.5% Y/Y)

 

-ex food & energy

0.2% (2.9% Y/Y)

 

FOMC Rate Decision

5.25% (unchanged)

Thursday

ECB Rate Decision

3.50% (0.25% increase)

 

Initial Claims

250K

 

Continuing Claims

1787K

 

Retail Sales

-0.1%

 

-ex autos

0.1%

 

Empire Manufacturing

-15.1

 

Philly Fed

-13.0

 

IP

0.1%

 

Capacity Utilization

79.7%

 

Business Inventories

0.2%

Friday

BOJ Rate Decision

-0.1% (unchanged)

 

Michigan Sentiment

60.1

Source: Bloomberg

 

So, clearly, we have a lot to absorb this week although today is lacking in new news.  A quick look at the PPI data shows why there is a growing cadre of people who are in the ‘inflation is over’ camp, as the Y/Y data is collapsing back to levels with which we are more familiar over the past decades.  However, I would highlight that core CPI remains well above the Fed target with only a very slow decline ongoing.  I remain in the sticky inflation camp on the basis of both personal experience and the fact that a critical part of the statistic, housing, is not actually showing any real declines.  Here is a link to an excellent article that helps explain the fact that rents are not declining very much at all, in reality, and if housing costs continue to climb, so will CPI.

 

I think the real question is what will happen if the CPI number is hot, say 5.5% core and showing no indication that the much hoped for slowing is ongoing?  How will the Fed respond the following day?  Remember, the market is largely priced for a pause skip with a 27% probability of a rate hike currently in the futures market, although an 80% chance of one by next month.  However, we all thought Australia was done and they hiked last week.  We all thought Canada was done and they hiked last week.  Will the Fed be willing to ‘surprise’ the market if the data points to continuing inflation pressures? 

 

This is especially timely as this morning there was a story in Bloomberg explaining that the idea that wage pressures are driving inflation is losing credence with a far less certain outlook on that prospect.  Essentially, a Fed paper was published explaining that while wages and inflation are correlated, the direction of causality, if there is one, is not clear.  That seems like a way for the Fed to be able to pivot their views to a different underlying cause and given housing’s huge importance to the total CPI number, ongoing rises in rentals would certainly be a concern.  One thing we do know is that if the CPI data come out soft, the equity market will rocket higher, at least initially, as the working assumption will be that the Fed is done.  Like I said, lots to anticipate this week.

 

As to today, the bulls remain in control as Friday’s very modest US rally saw Asia follow higher and Europe currently showing gains on the order of 0.5% – 0.6%.  US futures are following suit, with NASDAQ futures up 0.5% at this hour (7:45) and leading the way.

 

Treasury yields are little changed this morning with the yield up just 1bp although European sovereign yields are all lower, especially Italy (-5.6bps) after the news that former Italian PM, Silvio Berlusconi, passed away overnight.  As he was still quite active in Italian politics and a key force in the Forza Italia party, the story is that his passing will have removed some anxiety from markets and allow the Bund – BTP spread to narrow further still.  Perhaps of more interest is the increasing inversion in the 2yr-10yr portion of the curve, now back to -86bps, and a direct result of the massive amount of Treasury issuance that has been happening since the debt ceiling was removed.  In fact, today there are auctions for 3m, 6m and 1y bills and 3y and 10y notes to the tune of $278 billion, a huge amount of supply.  Do not be surprised if the curve inversion continues further.

 

Finally, looking at the dollar, it is generally, though not universally softer.  Given oil’s decline, it is no surprise that NOK (-0.35%) is the G10 laggard, but there is also a bit of weakness in the CHF (-0.25%) on the back of a slight decline in Sight Deposits there.  Meanwhile, the rest of the bloc is modestly firmer with no outsized gainers.  In the EMG bloc, ZAR (+1.1%) continues its recent strength, having rallied 7% this month on continued belief that the electricity situation in the country is getting better.  But away from that, and the fact that TRY (-0.7%) continues to slide, the rest of the bloc appears to be awaiting the upcoming onslaught of news this week.

 

I have a sense that by the end of this week, we may have new marching orders from the markets.  I would not be surprised to see a hot CPI print get the Fed to hike instead of skipping and if we see something like that, I would look for the dollar to test its recent resistance levels and potentially break through.  Correspondingly, if CPI is soft, I imagine the market will assume the Fed is done, and we will see equities rally with the dollar falling, at least for the first leg of the move.  We shall see starting tomorrow.

 

Good luck

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Worries Now Past

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With debt default worries now past

And jobs data set for broadcast

Risk preference has grown

As folks want to own

The highest of flyers, and fast

 

 

Meanwhile, the idea that the Fed

Will raise rates this month is now dead

Inflation is sliding

And pundits are chiding

Those who think price gains are widespread

 

In what can only be surprising to those who traffic in fear porn, the Senate passed the debt ceiling bill, and it heads to President Biden’s desk today for his signature and enactment.  This outcome was always going to be the case, especially once the House passed its debt ceiling increase bill.  All the histrionics about the president’s unwillingness to negotiate were simply part of the theater that goes with the current form of politics.  However, there were enough people who bought into the drama and created hedges so that this outcome has had a market impact.  You may recall that there were fears of a US debt default and if that were to occur, equity markets would sell off sharply.  And that is likely very true, if the US were to default on its debt, that is what would happen.  However, as I wrote from the beginning, that was a highly unlikely outcome.  Nonetheless, yesterday did see a rally in equity markets in the US with the rest of the world following suit overnight.  Risk is back baby!

 

Meanwhile, we got further confirmation that the Fed is going to pause skip a rate hike this meeting and the Fed funds futures market has now fallen to a 25% probability of any movement.  One of the interesting things about this ongoing repricing is that the data is not showing any signs of a slowdown that would help reduce inflationary pressures.  For instance, yesterday’s ADP Employment data was a much stronger than expected 278K, beating forecasts by more than 100K, while Initial Claims data continue to slide from their recent peak in March.  In other words, as we await today’s NFP data, the latest data points show continued strength in the US labor market.  Helping that story was the employment sub index of the ISM report, which while the headline remains weak at 46.9, saw the employment index rise to 51.4.  In other words, companies, at least manufacturing companies, are still looking for employees.

 

So, what is on the cards for today?  Here are the latest median forecasts according to Bloomberg:

 

Nonfarm Payrolls

195K

Private Payrolls

165K

Manufacturing Payrolls

5K

Unemployment Rate

3.5%

Average Hourly Earnings

0.3% (4.4% Y/Y)

Average Weekly Hours

34.4

Participation Rate

62.6%

 

Certainly, none of this data is vaguely representative of a recession, at least in the traditional definition, where growth turns negative, and Unemployment rises sharply.  While Powell and company may skip a hike this meeting, looking at this data, as well as at the fact that the inflation data, whether CPI or PCE, continues to run well above their target, even if that target is an average, certainly does not indicate the Fed is done hiking.  And remember, while we had all gotten quite used to the idea that interest rates at 0% or 1% were the norm, that is not the long-term reality.  Going back to 1970 (all the data I have), the average Fed funds rate has been 4.92%, essentially where we are today, with a peak of 20.0% in March 1980 and of course a floor of 0.0%, which was the level until the recent hiking cycle for the bulk of the previous 13 years. 

 

My point is that anticipation of the Fed stopping because Fed funds are so much higher than they were for the last decade is a serious mistake.  Rates can go much higher, and at this point, as long as the Unemployment rate remains at or near its current level, all the evidence of this Fed points to higher rates in the future.  In fact, it has been this thesis that drives my dollar expectations for continued strength because I believe the US economy is far better placed to handle higher rates than are most others, and these high rates will continue to support the greenback.  Once again, this is why I continue to believe the NFP data is far more important than CPI, as NFP will be the trigger for a policy change, not CPI (or PCE).

 

As we await the data, the market is clearly in a good mood.  As mentioned above, equity markets worldwide have rallied nicely with every virtually every major market higher by 1% or more (the Hang Seng jumped 4% last night on rumors of further Chinese government support for its still faltering economy.)  Naturally, US futures are also pointing higher this morning as well, with all three major indices up at least 0.5%.

 

Meanwhile, bond yields have edged higher this morning with Treasury yields up less than 1bp while European sovereigns are seeing yields creep up 2bp-3bps.  This has all the feel of a risk-on move with investors moving from fixed income to equity investments at the margin.  After all, no US default combined with a Fed pause skip is as good as it gets!

 

In a reversal of recent moves, commodity prices are feeling quite frisky this morning with oil (+1.5%) and copper (+1.5%) both benefitting from the same story that helped the Hang Seng, further Chinese stimulus on the way.  Meanwhile, gold (+0.1%) is holding onto yesterday’s sharp gains as the dollar is under pressure this morning.

 

Speaking of the dollar, despite my medium-term view of pending strength, it is definitely on its back foot this morning. The bulk of the G10 is firmer, with the highest beta currencies leading the way (SEK +0.85%, AUD +0.75%, NOK +0.6%) as commodity strength feeds through the market.  In addition, there is a growing belief that the RBA may have one more hike in them if data continues to show strength.  In the emerging markets, the story has largely been the same with almost the entire bloc firmer vs. the dollar led by KRW (+1.25%) and ZAR (+1.0%).  The rand story is clearly a commodity one, while the won story is in sync with the Chinese stimulus idea given how dependent South Korea is on Chinese growth.  I should note the renminbi has also rallied about 0.5% this morning on that very same story.

 

And that’s really it.  At this point, all we can do is wait for the labor market data to be released.  Until then, don’t look for any movement of note.  If we see another strong NFP print, something like last month’s 253K, I expect that the dollar should benefit and reverse some of its overnight losses, although equities may very well remain supported on the soft landing scenario that continues to reappear.  FWIW, this poet sees continued NFP strength for now, but we shall see shortly.

 

Good luck and good weekend

Adf

 

This Time They’ll Skip

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Twas clearly much more than a quip

When several Fed speakers did flip

The narrative’s tune

‘Bout rate hikes in June

Implying that this time they’ll skip

 

However, don’t think that they’re done

As they know that in the long run

Inflation’s not dead

And Jay Powell’s said

They’ll not stop til this battle’s won

 

We learned some important new things yesterday regarding the economy and the Fed’s current reaction function, namely that the Labor market continues to be pretty hot and, more importantly, that despite that fact, the Fed is almost certainly going to forego a rate hike this month.  Regarding the Labor market, yesterday’s JOLTs Job Openings data printed back above 10 million openings after a dip below that level in the previous two months indicated that there was less labor demand.  This is crucial because the Fed clearly watches this number closely as part of their employment situation dashboard, and more openings implies more wage pressure higher, the key thing Powell and friends are trying to ameliorate.  After the release, stocks, which had opened lower already, fell a further 0.5% as expectations for a 25bp rate hike in two weeks rose further.

 

But never fear, when it comes to supporting financial markets, the Fed is always there to help and yesterday was no different than normal.  While, as noted yesterday, non-voter and uber-hawk Loretta Mester was clear she saw no reason to pause, we subsequently heard from two other Fed speakers, Philadelphia’s Patrick Harker and Governor (and vice-chairman select) Phillip Jefferson, that now would be a good time to pause skip a meeting and look around at how the already 500 basis points of rates hikes are impacting the economy. 

 

“I am in the camp increasingly coming into this meeting thinking that we really should skip, not pause, but skip an increase.  A pause would mean the Fed is going to hold its policy interest rate steady for a while.  It is too soon to make that call,” explained Harker at the OMFIF* Economic and Monetary Policy Institute. [emphasis added]

 

Meanwhile, Philip Jefferson explained, “a decision to hold our policy rate constant at a coming meeting should not be interpreted to mean that we have reached the peak rate for this cycle.  Indeed, skipping a rate hike at a coming meeting would allow the Committee to see more data before making decisions about the extent of additional policy firming.” [emphasis added]

 

Rounding out the guidance was an article from the Fed Whisperer, the WSJ’s Nick Timiraos, highlighting these two speeches and clearing any doubt that a rate hike on June 14th is a dead issue.  So, summing things up, the Fed is going to hold fire in two weeks but fully well expects to tighten policy further starting in July unless something really significant occurs.  It should be no surprise that the Fed funds futures market has adjusted its pricing to a 30% probability of a hike in June (down from ~65% yesterday morning) and an additional 45% probability of one by July.  I am confident, that barring a remarkably strong NFP number on Friday, that we will see that June probability shrink even further, likely to around 20%.

 

How will this impact markets?  Well, yesterday saw the first equity weakness in a while, although US markets only fell about -0.6% on the day.  However, we are already seeing a rebound as Asian markets were broadly higher, albeit not dramatically so, and we are seeing real strength in Europe this morning with the DAX higher by more than 1.1% and leading the way.  The interesting thing about Europe is that early this morning we saw the PMI Manufacturing data releases and it was not a pretty picture.  Germany (43.2) was the laggard, but the Eurozone as a whole (44.8) was hardly something to write home about.  In fact, these PMI readings have been sub-50 since last July, a pretty strong indication of a recession.  Adding to the dysfunction was German April Retail Sales, falling -8.6% Y/Y, back to Covid levels, and before that, last seen in 1980!  Arguably, this ongoing weakness in economic data is going to stay Madame Lagarde’s hand when it comes to the ECB’s policy tightening.  The combination of lower headline CPI data and clearly weaker economic activity will make any more rate hikes, especially in the face of a Fed that is not hiking this month, much more difficult.

 

As to bond yields, this morning they have stabilized after their recent sharp declines.  Right now, we are looking at slightly higher yields, on the order of 1bp to 2bps, which seems to be merely a trading reaction to the previous week’s decline of 18bps.  With the House having passed the debt ceiling bill last night (it now moves to the Senate), that market drama seems to have ended so I expect we will get back to talking about the economy and the Fed again, as well as, of course, inflation.

 

Oil prices (-0.4%) are continuing their downward slide as regardless of any supply questions, this market sees demand as cratering as we head into a recession.  It is, of course, this price action, that has the deflationistas back crowing again about the inevitable collapse of CPI and how the Fed will need to reverse course quickly.  I am not in that camp, but only time will tell.  Meanwhile, gold (+0.25%) and copper (+2.3%) are telling a different story, especially copper.  It is hard to make sense of a rising copper price, the metal most closely associated with economic activity, and a simultaneous decline in oil.  But hey, nobody ever said markets made sense.  This will resolve itself at some point, but clearly not today.

 

Finally, the dollar is a non-event today, with about half the G10 and EMG blocs rising and the other half sliding, none more than about 0.3%.  Movement like this is hard to define as anything more than position adjustments and trading activity with no real catalysts seen.

 

On the data front, we get a bunch of releases today as follows:

 

  • ADP Employment 170K
  • Nonfarm Productivity -2.4%   
  • Unit Labor Costs 0%    
  • Initial Claims 235K   
  • Continuing Claims 1800K
  • ISM Manufacturing 0
  • ISM Prices Paid 3

 

The ADP number is a day late due to the Memorial Day holiday on Monday, but I cannot help but look at the productivity and ULC data and consider how negative that is for the economy writ large.  As well, we hear again from Patrick Harker, the last scheduled speaker before the FOMC meeting on the 14th.  Of course, we heard his views yesterday so I doubt there will be anything new.

 

A skip is not a pause, and I believe that the Fed will not be deterred from their mission at this stage.  This means that the market will continue to price in tighter Fed policy and the dollar is likely to benefit accordingly.

 

Good luck

Adf

 

 

 

*OMFIF is the Official Monetary and Financial Institutions Forum, a think tank devoted to banking and central banking.  I, too, have never heard of this before.