Tag Archives: #SNB

Tempt the Fates

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Inflation just won’t seem to die
No matter what Jay and friends try
Will he tempt the fates
To once more cut rates?
And if so, will bond yields comply?

 

It took until 1:10pm yesterday for Nick Timiraos at the WSJ to publish his article regarding the fact that Strengthening Inflation Poses Challenge for Trump, Fed.  I find the title of the article interesting as, to the best of my knowledge, Mr Trump has yet to take office and enact any policies.  But I suppose if Chairman Powell doesn’t like Trump (which seems to be the widely held view) he wanted to ensure his mouthpiece took a dig and distracted the audience from Powell’s problems.

Regardless, yesterday’s CPI report was a bit firmer than forecast, at least at the second decimal place, which is enough for the punditry to discuss.  Of course, it is remarkable that a statistic of this nature is considered down to the second decimal place given the broad uncertainty over its measurement overall.  However,  looking at the chart below, which shows the monthly CPI readings for the past ten years, it is not hard to see that monthly inflation bottomed back in June and appears to be finding a new home at the 0.3% or higher level.  

Source: tradingeconomics.com

I showed the 10-year chart to also highlight that pre-Covid, the monthly readings were somewhere between 0.1% and 0.2% consistently.  My point is that 0.3% per month annualizes to about 3.7% which is as good a guess as any for how inflation is going to play out going forward absent some major fiscal and monetary changes.

Aside from the fact that this is important because we all suffer the consequences in our daily lives, from a markets perspective, I believe this is the money line in the article [emphasis added], “Officials have indicated sticky inflation could lead them to slow the pace of rate reductions or stop altogether.”  Yet, despite this strong hint that the Fed is getting uncomfortable with the market’s current assessment of how much further Fed funds are going to decline, the futures market is pricing a 98.6% probability of a cut next week.  

In fairness, the market is now pricing only two more rate cuts after next week for all of 2025, a number that has been declining slowly over the past month.  But ask yourself how the Fed will behave if their firmly held belief that inflation is still heading toward their 2% goal starts to falter under the weight of continued high readings.  There are a few analysts who are discussing rate hikes for next year for just this reason.  That, my friends, would upset the apple cart!

The central bank theme of the week
Is current rates need quite a tweak
Despite CPI
That’s still on the fly
More havoc, these bankers, will wreak
 
Down Under, though they didn’t cut
The doves’ case was open and shut
The Swiss and Canucks
Made changes, deluxe
While Christine, a quarter, will strut

While we are beginning to see some changes in the market’s perception of the Fed’s future path, those changes are not obvious elsewhere.  So far this week, the RBA left rates on hold, as they had promised, but explained the need to cut was upon them, demonstrating far less concern over inflation than in the past.  You may recall that the AUD fell sharply after the RBA statement put cuts in play going forward.  Then, yesterday, the BOC cut 50bps, as expected, as they, too, have turned their focus to economic activity and away from inflation, which continues above their target.  This morning, the Swiss National Bank surprised the markets with a 50bp cut, taking their base rate back down to 0.50%, expressing concern that inflation was slowing too rapidly and could become a problem.  Finally, shortly the ECB will announce their policy rate with the market highly confident a 25bp cut is on the way, although there are a few looking for 50bps.

The funny thing about all these cuts is that other than Switzerland, where recent CPI readings were at 0.7%, inflation remains above target levels and is demonstrating the same type of behavior as in the US, where it bottomed during the summer and is rebounding.  As well, especially in Europe, unemployment does not appear to be a major problem in these nations.  This begs the question, why are central banks so keen to cut rates if inflation remains sticky above their target levels and economic activity is hanging on?  

I have no good answer for this although I suspect there may be significant pressure from finance ministries regarding the cost of all that government debt that is outstanding and needs to be refinanced.  Alas, even though almost every central bank’s primary mandate is to maintain low inflation, it has become clearer by the day that following that mandate is not seen as important as other concerns.  Whether those concerns are economic activity or financing outstanding debt, or perhaps something else, I fear that we are heading back into a world where higher inflation is going to be the norm everywhere in the world.  Plan accordingly.

Ok, after another couple of record high closes in the US yesterday, let’s see how things have played out ahead of the ECB this morning.  In Asia, both Japan (+1.2%) and China (+1.0%) rallied on the brightening tech outlook, the prospect of further rate cuts and the ongoing hopes for that Chinese bazooka to finally be fired.  As well, Hong Kong (+1.2%) and Korea (+1.6%) also fared well, although the rest of the region was more mixed on much smaller movement.  In Europe, the best description ahead of the ECB is unchanged, with every bourse within 0.1% of Wednesday’s closing levels.  US futures at this hour (7:15) are pointing modestly lower, however, down about -0.2%.

In the bond market, despite all the surety of rate cuts, investors are not comfortable holding duration, and we are seeing yields continue to rise across the board.  Treasury yields are higher by another 3bps and back to 4.30% while European sovereign yields are all higher by between 3bps and 5bps.  It seems the bond markets are not convinced that central banks are behaving properly.  Perhaps the “bond vigilantes” will truly make a return after all.

In the commodity markets, oil (+0.1%) which managed to capture the $70/bl level is holding on this morning after the IEA raised its demand forecast for 2025 based on increased expectations for Chinese demand (because of the stimulus that is expected.). In the metals market, that Chinese stimulus is helping copper (+0.5%) although the precious sector is consolidating yesterday’s gains with gold (-0.3%) backing off slightly and silver unchanged.  However, gold is back above $2700/oz and appears to have finished its consolidation.

Finally, the dollar is mixed this morning, broadly holding onto its recent gains, but seeing some weakness against specific currencies.  For instance, BRL (+1.0%) responded to the fact that the central bank there, bucking the global trend, hiked the Selic rate by 100bps, a quarter point more than expected, as their concern over rising inflation increases.  (It seems they are one of the few central banks that is focused on their job, not the politics!). But away from that outlier move, we see AUD (+0.45%) rising on stronger than expected jobs growth data while NOK (+0.4%) is continuing to benefit from oil’s recent gains.  On the flip side, CHF (-0.35%) is suffering for the larger than expected SNB rate cut and GBP (-0.2%) is under modest pressure as traders debate whether the BOE will cut rates next week or not.

On the data front, Initial (exp 220K) and Continuing (1880K) Claims lead the way alongside PPI (0.2%, 2.6% Y/Y headline, 0.2%, 3.2% Y/Y core) at 8:30 this morning.  Beyond that, there is a 30-year auction this afternoon and that is really it.  I don’t see PPI having a great deal of impact and with CPI behind us, and Timiraos having told us that the Fed is going to slow the pace of cuts, I’m not sure what else there is to watch.  Obviously, this morning’s ECB meeting matters, but really, it is hard to get overly excited about the outcome there.  I suspect that attention will now be focused on the FOMC next week, with much more concern over the dot plot and SEP than the 25bp cut that seems a foregone conclusion.  

If the Fed is truly slowing the pace of cuts, once again, it becomes difficult to see how the dollar will soften vs. its major counterparts. Keep that in mind for now.

Good luck

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Fearmongers Now Say

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A question that’s going around
Is where will the buyers be found
For all the new debt
That nations are set
To issue as budgets compound
 
As well, the fearmongers now say
A crisis is coming our way
If voters elect
The folks who reject
The status quo finance cliché

 

As markets return from yesterday’s US holiday, activity remains somewhere between muted and ordinary in most markets.  At times like these, it is interesting to take note of the tone of the articles in financial journals, whether the WSJ, Bloomberg or the New York Times, as they are the place where I find politics is inserted into the discussion.  

For instance, there have been several articles regarding the pending French election and the market’s concern about a victory by Marine Le Pen on the right.  The thesis seems to be if her RN party wins and takes over parliament, that her plans will result in a collapse in French finances based on the promises she has made throughout the campaign.  There are many analogies to what occurred in October 2022 in the UK, when the newly elected PM, Liz Truss, put forth a program of unfunded spending and the Gilt market fell sharply.  You may recall the result was that the BOE had to step in to buy Gilts even though at that time, they had just begun to sell them to reduce the size of their balance sheet. 

Of course, what gets far less press is the fact that UK insurance companies had levered up their balance sheets because of ZIRP as they tried to earn a sufficient return to match their pension liabilities and when the BOE started tightening policy, those companies were already in trouble.  Certainly, the market response accelerated the problem, but even without Truss, as the BOE kept raising rates, the outcome would likely have been the same.  However, it was politically expedient for the press to blame Truss and the Tories.

Now consider the US, where government profligacy is truly breathtaking as the current government is borrowing $1 trillion every 100 days or so.  Certainly, this topic has been reported, although it is difficult to find a discussion from the mainstream media that makes the leap that spending as much as is currently happening is the underlying cause.  (Yes, there are many stories of this from conservative media as well as on Twitter, but not on the CBS Nightly News.)  However, those same mainstream sources threaten everyone that in the event Donald Trump is elected, it will spell the end of the bond market and the US economy because of his policy proposals of tax cuts and supporting energy growth.

It is commentary of this nature that, in my opinion, has reduced the value of mainstream media via the constant politicization of every subject.  This is also why alternate media sources, like the numerous excellent articles on Substack, have become so popular and widely read.  Analysts who are not beholden to a corporate policy and politics are able to give much more accurate and politically unbiased views.

At any rate, there was much concern ahead of this morning’s French bond auctions (they issued €10.5 billion across various maturities from 3-8 years) as this was the first attempt to sell debt since President Macron called his snap election after his European Parliament electoral disaster.  However, happily for all involved (except the doom mongers) things went just fine with a solid bid-to-cover ratio and a modest decline in market spreads.  All told, while nobody knows the future, it is difficult to expect that a Le Pen government will be any worse financially than the current Macron led government.  After all, France has just been warned by the European Commission that it must reduce its budget deficit from the current 5.5% to 3.0% as per the Maastricht Treaty, and there is no “far-right” influence on the current government.

Enough politics, let’s recap the overnight markets.  Asian markets were mixed as the Nikkei edged higher (+0.15%) but the Hang Seng (-0.5%) gave back some of yesterday’s spectacular rally.  The laggard, though, was mainland China (-0.7%).  In Europe this morning, despite the fears of a Le Pen victory, the CAC (+1.0%) is the leading gainer as either we are seeing a trading bounce after a terrible week last week, or maybe the initial hysteria is being seen for what it was, unfounded hysteria.  Meanwhile, as the BOE just left rates on hold, as widely expected, the FTSE 100 has bounced about 0.3% in the first 15 minutes since the announcement and is up 0.5% on the day.  Overall, Europe is having a good day with the DAX and virtually all markets ahead.  US futures, too, are firmer this morning, with both the NASDAQ and S&P higher by 0.5% or more although the Dow continues to lag.

In the bond market, Treasury yields have backed up 2bps this morning but the picture in Europe is much more mixed.  German yields are higher by 3bps, but UK yields have slipped a similar amount.  In fact, looking at all the nations there, it appears that there is slightly less concern over Europe as a whole as French yields are only higher by 1bp and Italian yields have slipped 1bp, thus narrowing the spread with Germany overall.  Turning to Asia, JGB yields rose 2bps, following USDJPY higher, or perhaps anticipating a higher inflation reading tonight.

In the commodity markets, crude oil (+0.15%) is edging higher this morning, although it slipped in futures trading yesterday (the only market open).  This morning brings the inventory data which is anticipating a draw of 2M barrels.  Metals markets are solid again with gold (+0.4%), silver (+1.7
%) and copper (+0.2%) all continuing their rebound from the dramatic decline two weeks ago.

Finally, the dollar is stronger this morning against most of its counterparts, notably the JPY (-0.3%) and CNY (-0.1%).  I highlight these because the yen story remains critical to the global financial markets, and it appears that Japanese investors are beginning to turn back toward Treasuries and away from JGBs supporting the moves in those markets and USDJPY.  

Regarding China, last night the PBOC fixing was at 7.1192, its highest level since November 2023 and the largest move (33 pips) in weeks.  It appears that there are numerous changes being considered and ongoing in China regarding its domestic bond market (the PBOC is looking to become more involved to support liquidity) as well as the overall monetary structure (there is talk that they will be adjusting the framework of three different rates to something more akin to what Western central banks use with a single policy rate).  In the end, given the ongoing lackluster performance of the Chinese economy, a weaker CNY remains my base case and while it may be gradual, it seems it is the PBOC’s view as well.  The onshore market continues to trade at the edge of the 2% allowable band and the offshore market is a further 35bps higher (weaker CNY) than that.  

Elsewhere, ZAR (-0.85%) which has had a good run on the back of the ultimate electoral outcome, seems to be afflicted with some profit-taking and then most of the rest of the currencies are softer vs. the dollar by about 0.2%.  One last exception is CHF (-0.65%) which has slipped after the SNB cut their policy rate by 25bps, as expected, to 1.25%.

On the data calendar today, we see Initial (exp 235K) and Continuing (1810K) Claims, Philly Fed (5.0), Housing Starts (1.37M) and Building Permits (1.45M), all at 8:30.  Then, later this afternoon, Thomas Barkin of the Richmond Fed will undoubtedly remind us that things are moving in the right direction, but patience is required.

Summing it all up, while I didn’t specifically mention it, the key thing in financial markets continues to be Nvidia, which is much higher in pre-market trading again, and apparently is the driver of everything.  However, traditional relationships have been under strain as although it appears to be a risk-on day, both the dollar and precious metals are firmer.  Overall, nothing has changed my view that the Fed is going to remain firm for now, and that (too) much credence will be assigned to next Friday’s PCE data.  But such is the state of the world.

Good luck

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Some Regrets

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Six central bank meetings this week
Will give us a new inside peak
At their dedication
To wipe out inflation
And just how much havoc they’ll wreak
 
Investors have made all their bets
And so far, today, risk assets
Show green on the screen
Ere any convene
Methinks, though, there’ll be some regrets

 

It is central bank week as we hear from more than half of the G10 between tomorrow and Thursday.  The BOJ kicks things off followed by the RBA, FOMC, Norgesbank, the SNB and finally the BOE.  A great deal of stock has been put into these meetings by both traders and investors as everyone is seeking clues for the future. Alas, looking for central banks, whose crystal balls are cloudier than most, to give solid clues is probably not the best idea.  But let’s take a quick look at each meeting and expectations:

BOJ – next to the Fed, this is the meeting that has gotten the most press both because Japan is the largest of the other economies, but also because there is much talk that they are going to raise their base rate for the first time in 17 years!  At this point, despite the most recent dovish comments from Ueda-san two weeks’ ago, the best indicator seems to be Nikkei News, which has had several articles (courtesy of Weston Nakamura’s Across the Spread substack) declaring that rate hike is coming.  Apparently, they have a perfect record in these forecasts, so it looks a done deal.

Arguably, the question is will they do anything else beyond moving from NIRP to ZIRP?  There are several analysts who believe they will adjust YCC as well, either eliminating it completely, or changing the terms to buy a fixed amount each period rather than responding to market conditions.  As well, they continue to buy equity ETFs and REITs so it is quite possible they end those programs.

The funny thing is so many believed that when the BOJ finally started their tightening cycle that would be the signal for selling JGBs and buying yen.  Well, if that has been your strategy going into the meeting, it has not worked out that well.  JGB yields (-3bps) have been consolidating around the 0.75% level virtually all year while the yen, which did have a little pop higher at the beginning of the month, is now back close to 150 again.  Regarding the yen, the driver in the currency continues to be US interest rates and the incremental adjustment by the BOJ is just not enough to move the needle absent a firm commitment by Ueda-san to hike regularly going forward.  And there is no evidence of that.  As to JGB yields, a slow grind higher seems possible, but a run up above 1.0% seems highly unlikely, especially given the economic cycle has just turned down with two consecutive quarters of negative real GDP activity.

RBA – there is no policy movement anticipated here for this meeting as both growth and inflation remain above targets but have not been relatively stable.  In fact, there is a minority looking for a cut, but that seems unlikely right now simply based on the inflation data.  Generically, I find it extremely difficult to believe that any central bank will be able to cut their rates with inflation running well above the target and, in most places, looking like it has found a bottom.  I realize there is a significant desire to cut rates by virtually all central bankers, but given the current economic situation, if they want to salvage whatever credibility they may have left, it is a hard case to make to cut right now.  

One other thing to remember is that Australia is more dependent on China than any other G10 nation and China last night published better than expected economic data with IP jumping to 7.0%, far better than expected and its fastest pace in two years.  If China is starting to pick up again, that will be a net benefit for Australia and put upward pressure on commodity prices and prices in general Down Under.  I think they remain on hold for a while yet.

FOMC – suffice to say no change in rate policy but we will discuss the other features tomorrow regarding the dot plot and potential guidance.

SNB – The Swiss may be the other central bank to move this time as inflation there has fallen to 1.2%, well below the ceiling of their 0% – 2% target range.  While the market consensus remains no change and the franc has softened nearly 4% vs. the euro so far this year, we cannot forget that it remains far stronger than its historic levels and the opportunity to weaken the currency a bit to help its export industries while inflation remains quiescent is something that may appeal to SNB President Jordan.  Keep an eye out here.

Norgesbank – No change here as inflation remains far too firm, ~5%, while oil’s recent rebound has helped the currency rebound.  I don’t think there is anything to be learned from this outcome.

BOE – Here, too, no change is expected and there is no press conference.  As such, the most interesting question will be the vote split.  Last time, the split was 1-6-2 for a cut, hold and hike respectively.  (Talk about not seeing things the same way!  How is it possible that two committee members can look at the same data and believe opposite conclusions?  Seems there is some ideology in play there.). At any rate, a change in the vote count will be a signal.  Recent data has shown that wages are still hot, but slowing down, while inflation is similarly hot but slowing.  The latest CPI data will be released on Wednesday so the BOE will have that to account for as well as everything else.  At this point, I’m in the no move camp with the same split of votes the outcome.

With that recap, let’s look at the overnight session briefly.  As mentioned above, equities are green everywhere with the Nikkei (+2.7%) leading the way around the world and pushing back close to the key 40K level.  But there was strength in every market in Asia.  Europe, too, is all green, albeit less impressively, with gains on the order of 0.25% while US futures are looking good at this hour (7:45) with the NASDAQ leading the way, up 1.0%.  (Here, many are counting on more amazing news from Nvidia as they have a weeklong conference starting today.)

After last week’s rush higher in yields on the strength of the hotter inflation prints from the US, this morning is seeing very little movement overall ahead of the central bank meetings this week.  Basically, every market is within 1bp of Friday’s closing levels, with a few higher and others lower.  One other thing I failed to mention was the PBOC will be revealing their 5-year Loan Prime Rate on Tuesday night, and while no change is forecast, it was last month when they cut this to help the property market that kicked off the idea more stimulus was coming.

Oil prices continue to perform well on the back of several different factors.  First, we have seen inventory draws much greater than expected in the US.  At the same time, Ukraine has damaged several Russian refineries thus reducing the supply of products and we still have OPEC+ maintaining their production restrictions.  Add to this China’s apparent rebounding growth supporting demand and that is a recipe for higher prices.  As to the metals markets, despite the dollar’s recent rebound, gold continues to hold its own and copper is still rising consistently.  In fact, the red metal is higher by 5% in the past week, a potential harbinger of better global growth.

Finally, the dollar is a touch softer this morning, but only a touch.  The biggest mover is ZAR (-0.6%) which is opposite the broader trend of very slight dollar weakness.  While South African equities have been drifting lower of late, today’s move feels more like an order in the market than a fundamental change.  Away from that, though, no currency of note has moved more than 0.2% on the day as traders await the onslaught of central bank news.

Speaking of news, we have other things beyond the central banks as follows:

TuesdayHousing Starts1.43M
 Building Permits1.50M
ThursdayInitial Claims216K
 Continuing Claims1815K
 Philly Fed-2.5
 Current Account-$209.5B
 Existing Home Sales3.95M
 Flash PMI Manufacturing51.7
 Flash PMI Services52.0
Source: tradingeconomics.com

In addition, starting Thursday, the first Fed speakers will be back on the tape to reinforce whatever message Chair Powell articulates on Wednesday.

From my vantage point, it appears that the BOJ’s rate hike has been accepted and priced in already, while the biggest surprise could be Switzerland.  However, the fate of the dollar lies in the hands of Powell, and that is an open question we will discuss tomorrow.  For today, don’t look for too much of anything in any market.

Good luck

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Concerns Are Severe

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One look at the dot plot makes clear
Inflation concerns are severe
So, higher for longer
Is growing still stronger
And Jay implied few cuts next year

First, let’s recap the FOMC meeting.  The term hawkish pause had been used prior to the meeting as an expectation, and I guess that was a pretty apt description.  While they left policy on hold, as expected, the change in the dot plots, as seen below, indicate that even the doves on the Fed see fewer rate cuts next year, with just two now priced in from four priced in June.

Source: Fedreserve.gov

A quick reading shows that a majority of members expect one more hike this year, and now the median expectation for the end of 2024 has moved up to 5.125%, so 50bps lower than the median expectation for the end of 2023 and 50bps higher than the June plot.  To me, what is truly fascinating is the dispersion of expectations in 2025 and 2026, where there are clearly many opinions.  And finally, the longer run expectation has risen to 2.5% with many more members thinking it should be even higher than that.  The so-called neutral rate estimations seem to be creeping higher.  If you think about it, that makes some sense.  After all, given the ongoing forecasts for continued labor market tightness due to demographic concerns, and add in the massive budget deficits leading to significantly higher Treasury debt issuance, there is going to be pressure on rates to find a higher level.

The market response was quite negative, albeit not immediately, only after Powell started speaking.  But in the end, equity markets fell across the board in the US, with the NASDAQ taking the news the hardest, down -1.5%, as its similarity to long duration bonds was made evident.  Asian markets all fell overnight as well, with most tumbling more than -1.0% and European bourses are all under similar pressure, down -1.0% or so as well.  The one exception in Europe is Switzerland, where the SNB surprised the market and left rates on hold resulting in a weaker CHF and a very modest gain in their equity market.

However, the bigger market response was arguably in bonds, where yields rose to new highs for the move with the 2yr at 5.15% and the 10yr at 4.43%.  Once again, I point to the significant increase in debt that will be forthcoming from the US Treasury as they need to fund those budget deficits.  I have been making the case that a bear steepener would be the more likely outcome for the US yield curve.  That is where long-term rates rise more quickly than short-term rates due to the US fiscal policy and shrinking demand for US debt by key players, notably the Fed, but also China and Japan.  Nothing has changed that view.

Then early this morning, up north
Both Sweden and Norway brought forth
A quarter point hike
To act as a dike
Preventing price rises henceforth

After the Fed’s hawkish pause, we turn our attention to Europe, where the early movers, Sweden and Norway, both hiked twenty-five basis points, as expected, while both hinted that further hikes are not out of the question.  Inflation remains higher than target in both nations and in both cases, the currency has been relatively weak overall.  Switzerland left rates on hold, pointing to the fact that for the past three months, inflation has been within their target range, and they are beginning to see downward pressure on economic activity which they believe will keep that trend intact.

And lastly, from London we’ve learned
Another rate hike has been spurned
Though voting was tight
They said they’re alright
With waiting to see if things turned

As to the bigger story, the UK, expectations were split on a hike after yesterday’s tamer than expected CPI report while the pound fell ahead of the news.  And the change in expectations was appropriate as in a 5-4 vote, the BOE opted to remain on hold for the first time in two years.  They see that inflation may be easing more rapidly than previously expected, and they are concerned about overtightening.  While I have a hard time understanding how a 5.15% Base rate is tight compared to CPI running at 6.7% and core at 6.2%, I am clearly not a central banker.  At any rate, the pound fell further on the news and is now at its lowest level since March, while the FTSE 100 rallied back and is close to flat on the day from down nearly -1.0% before the announcement.  Gilt yields, however, are moving higher as the bond market there doesn’t seem to believe that the BOE is serious about fighting inflation.

And really, those are today’s key stories.  Late yesterday, Banco Central do Brazil cut the SELIC rate by 0.50%, as expected, and at the same time the BOE announced, the Central Bank of Turkey raised their refinancing rate by 5 full percentage points, to 30.0%, exactly as expected.  And to think, we get concerned over rates at 5%!

As to the rest of the day, there is a bunch of US data as follows: Philly Fed (exp -0.7), Initial claims (225K), Continuing Claims (1695K), Existing Home Sales (4.1M) and Leading Indicators (-0.5%).  As is typical, there are no Fed speakers scheduled the day after the FOMC meeting, but we will start to hear from them again tomorrow.

Putting it all together tells me that the Fed is not nearly ready to back off their current stance and will need to see substantial weakness in economic activity before changing their mind.  Meanwhile, last week’s ECB meeting and this morning’s BOE meeting tell me that the pain of higher interest rates in Europe is becoming palpable and the central banks are leaning more toward inflation as an outcome despite their mandates.  This continues to bode well for the dollar as the US remains the place with the highest available returns in the G10.

Tonight, we hear from the BOJ, where no change is expected.  I would contend, though, that the risk is there is some level of hawkishness that comes from that meeting as being more dovish seems an impossibility.  As such, there is a risk that the yen could see some short-term strength.  Keep that in mind as you look for your hedging levels.  

Good luck

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Some Dismay

Posted on by 
While everyone’s certain that Jay
Will leave rates alone come Wednesday
The curve’s longer end
Is starting to trend
Toward rates that might cause some dismay

The problem remains his frustration
That he can do naught ‘bout inflation
As oil keeps rising
It’s demoralizing
For Jay and his rate formulation

The overnight session was quite dull overall with virtually no new data or information on the macroeconomic front and a limited amount of commentary from the central banking and financial poohbahs of the world.  Friday’s desultory US equity market performance was followed by a mixed session in Asia while European bourses are all in the red after the Bundesbank indicated that Germany would have negative growth in Q3.  As well, after last week’s ECB rate hike, we did hear from one of the more hawkish members that further hikes are possible, although listening to Madame Lagarde’s comments, that seems quite a high bar at this time.

So, given the limited amount of new information, it seems that it is time for central bank prognostications.  The first thing to note is that while the Fed is certainly the main act this week, there are no less than a dozen other major interest rate decisions due this week including the BOE, BOJ, PBOC, Swedish Riksbank, Norgesbank, SNB and Banco Central do Brazil.  

While much has been written about the FOMC on Wednesday, with the current market pricing just less than a 1% probability of a hike, the European banks that are meeting are all expected to follow the ECB and hike by 25bps.  Meanwhile, the PBOC remains caught between a rock (slowing economic growth) and a hard place (a weakening currency) and seems highly likely to follow the Fed’s lead and leave rates on hold.  

The BOJ is also very likely to leave their rate structure on hold, but questions keep arising regarding any other potential tweaks to the YCC framework.  However, given the relatively strong denials of anything like that from Ueda-san at the end of last week, I am inclined to believe they are comfortable where they are.  

Finally, a look down south shows that Brazil is forecast to cut the SELIC rate (their Fed funds equivalent) by 50bps to 12.75% with a handful of analysts calling for a 75bp cut.  Of course, inflation in Brazil has fallen from effectively 12% last summer to 4.65% now, so real rates are still remarkably high there which is the key reason the real has been such a great performer over the past twelve months, having risen ~8%.

The only market that is really showing much movement is oil, which is higher yet again this morning, by another 0.5% and now above $91/bbl.  It is becoming very clear that the OPEC+ production cuts are having the impact that MBS desired, with tightening supply meeting ongoing demand growth, despite slowing economic activity.  The one thing that should remain abundantly clear to all is that no amount of effort by Western governments to reduce demand for fossil fuels is going to have the desired impact as developing nations will not be denied their opportunities to improve their own economic situation and that generally takes access to energy.  To date, fossil fuels continue to prove to be the most cost-effective and efficient sources, so that demand will just not abate.  Oil prices are going to continue to head higher, mark my words.

And truthfully, on this rainy Monday morning in NY, that is pretty much all the excitement that we have ongoing.  The data this week is focused on Housing and expectations are as follows:

TuesdayHousing Starts1437K
 Building Permits1440K
WednesdayFOMC Rate Decision5.50% (current 5.50%)
ThursdayInitial Claims225K
 Continuing Claims1695K
 Philly Fed-1.0
 Existing Home Sales4.10M
 Leading Indicators-0.5%
FridayFlash PMI Manufacturing48.2
 Flash PMI Services50.6

Source: Bloomberg

A side note regarding the data is that the Leading Indicators Index is forecast to decline again, which will be the 17th consecutive decline, a very strong indication that future economic activity seems likely to suffer.  Of course, this is just one of the numerous signals of an impending recession (inverted yield curve, ISM/PMI sub 50.0, etc.) that have yet to play out as they have done historically.  Perhaps the UAW strikes will be enough to tip things over, especially if they widen in scope, but that seems premature. 

In addition, we are beginning to hear more about a potential government shutdown as the House has not yet completed its funding bills but my take here is that while the rhetoric may heat up, the reality is that a continuing resolution will be passed and that this is just another tempest in a teapot in Washington, SOP really.

When looking a little further ahead, I continue to see a far better chance that the Fed remains the most hawkish of the major central banks, and that higher for longer really means just that.  Economic activity elsewhere, notably in Europe and China, is suffering far more acutely than in the US, at least statistically, and that implies that this week’s rate hikes across the UK and the continent are very likely the end of the cycle.  I am not convinced that the Fed is done.  That combination leads me to continue to look for relative dollar strength over time.  For asset/receivables hedgers, keep that in mind.

Good luck

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A Pitiful Claim

Posted on by 
Said Jay, we’ve “a long way to go”
Ere driving inflation too low
Employment’s still tight
But we’ll get it right
Or not… it’s too early to know

His colleagues, though, aren’t in sync
As some of them seemingly think
They’ve tightened enough
And now would rebuff
The call for more Kool-Aid to drink

Lots to touch on this morning between Powell’s testimony yesterday along with other Fed speakers and then a raft of central bank meetings with rate hikes across the board.

 

Starting with the Fed, Powell tried to be very clear that his expectation, and that of the bulk of the FOMC, is interest rates have further to rise.  While they chose to skip a hike last week, they are under no illusion that they have beaten inflation.  Instead, Powell was very clear in his comments that they “have a long way to go” before they have finished the job with inflation.  Of course, yesterday I laid out a theme of why their medicine for inflation is not likely to be that effective, but that is not a conversation that Powell, or any FOMC member, is likely to entertain.

 

However, despite Powell’s insistence that there are likely two more 25bp rate hikes in the offing, we are finally beginning to hear some dissent from the rest of the committee.  Yesterday both Raphael Bostic from Atlanta and Austin Goolsbee from Chicago were clear that a pause at the current level made the most sense and they would support that outcome.  While Governor Christopher Waller remains on board with further rate hikes, Bostic is not a voter (Goolsbee is) so I expect that the July meeting will have a lot of discussion.

 

Interestingly, the market reaction was different in different markets, with the equity markets hearing Powell and accepting his words at face value thus selling off, while the FX market seems more suspect, with the dollar failing to gain after his comments.  In fact, the euro has traded back above 1.10 this morning for the first time in more than a month.  As to the Treasury market, yields are pushing higher again, with 10yr yields up by 1.5bps this morning, but the real movement has been in the 2yr which has seen the curve inversion push back to -99bps.  Bond investors seem to believe Powell.

In Europe, though, things ain’t the same
As central banks still try to blame
Their failure to slow
Inflation and grow
On Russia, a pitiful claim

In the meantime, three central banks met today in Europe and all three hiked rates, with two, Norway and the UK, hiking by 50bps and Switzerland hiking just 25bps.  The 50bp hikes were more than expected and indicative of the fact that both nations, and in truth the entire continent, remain far behind the curve in their respective inflation fights.  Alas, for these nations, too, I fear they are not using the best tool to address the issue as all were guilty of excessive fiscal stimulus and all face worse demographic trends than the US, so are unlikely to get the desired response from rate hikes. 

 

It should be no surprise that both the pound and krone have rallied sharply on the day, with NOK higher by 1.3% and the best performing currency in the world, as investors and traders are concluding that these central banks are going to keep at it until such time as inflation finally does slow down.  The pound reacted immediately, with a quick 0.5% pop, although it is since retraced those gains and is only slightly higher on the day now. 

 

What should we make of all this central bank activity?  While there are a growing number of analysts and economists who continue to believe that inflation is due to decline sharply over the summer, apparently none of them work in any central bank.  The relative amount of tightness from one bank to another may vary slightly, but other than the BOJ, which is completely uninterested in adjusting its policy anytime soon, it is very easy to believe that interest rates have higher to go from here.  Plan accordingly.

 

So, what have these comments and actions wrought in markets?  Well, my entire equity market screen is red this morning with Japan and China both sharply lower as well as every major index in Europe falling by at least -1.0%.  US futures are also in the red after a weak session yesterday, and it is very easy to believe that we are due a correction, if nothing else, given the remarkable run up we have seen lately.

 

Bond yields, as mentioned above, are generally higher, although 10yr Gilts are bucking the trend, falling 3bps in the wake of the BOE action as investors are hopeful they are truly going to be able to halt the inflationary spiral.  As with most other things, JGB’s are not following suit and in fact, with the 10yr yield back down to 0.367%, virtually all discussion of the end of YCC has vanished.  Ueda-san is one lucky guy.

 

On the other hand, oil (-2.1%) is under pressure this morning as the idea of higher interest rates slowing economic growth continues to pervade the market.  Perhaps more surprisingly, both copper and aluminum have rallied a bit and are holding onto their gains in the face of higher rates.  Ultimately, copper especially, is a resource that is in short supply for all the grandiose electrification plans that are bandied about by politicians worldwide, and so I expect, just like oil, there is a structural deficit and it should trade higher.  I am simply surprised it is doing so in the current environment.

 

Finally, the dollar is mixed this morning, as after the NOK, the rest of the G10 is +/- 0.2% from yesterday’s closing levels, hardly enough to discuss.  In the emerging markets, the biggest mover is TRY (-2.3%) after the central bank disappointed by only raising rates from 8.50% to 15.0%!  With a new central bank chief, the market was expecting a move to 20.0%, which would still be far below the current level of CPI there, which at last reading was 39.6%.  But away from that, the dollar is mixed with no outliers in either direction.

 

Today we do get a lot of data as follows: Chicago Fed National Activity Index (exp -0.10); Initial Claims (259K); Continuing Claims (1785K); Existing Home Sales (4.25M); Leading Indicators (-0.8%) and KC Fed Manufacturing Index (-5).  Chair Powell also speaks to the Senate Banking Committee today, but I doubt much new will come from that.  Look at the Initial Claims data, which is the best real time indicator of the employment situation as any jump there will likely get tongues wagging about the end of the Fed rate hikes.

 

Right now, investors are a bit nervous about just how hawkish the Fed is going to ultimately be, so my take is we will see caution, meaning profit taking and a modest correction in risk assets, until such time as participants are all convinced that the pivot is coming.  The fact that a pivot means the economy is distressed does not seem to matter right now. As to the dollar, it will have a hard time as long as traders question the Fed’s conviction while other central banks raise rates.  So, while the yen and renminbi should be the worst performers, the G10 is likely to outperform the buck for now.

 

Good luck

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Not the Nadir

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The Chairman explained to us all
Preventing the ‘conomy’s stall
Required a cut
Of twenty-five but
Don’t look for, rates, further to fall

However, it’s not the nadir
For all rates, that’s certainly clear
Brazil cut a half
While BOJ staff
Will check if they’re now too austere

As I mentioned on Monday, the Fed was merely the first in a long list of major central banks meeting this week. By now we all know the FOMC cut rates by 25 bps and released a statement that was certainly more hawkish than many had hoped for expected. The vote was largely as expected, with the July dissenters, George and Rosengren, continuing to vote for no change, while this month, St. Louis Fed President James Bullard also dissented, voting for a 50bp cut. Of more interest was the dot plot, which showed five members forecasting no further cuts this year, five looking for one more cut and seven looking for two cuts. That is actually quite a bit more hawkish than expected going into the meeting. In the end, equity markets sold off initially, but rallied late in the day to close essentially unchanged. Treasuries rallied all day leading up to the meeting, but ceded those gains in the wake of the announcement and press conference while the dollar rallied against most currencies, although it has given back those gains overnight.

Powell’s explanation for cutting was that the committee was still concerned over issues like global growth, trade policy and Brexit, and so felt a cut was merited to help insure steady growth. My impression is Powell is not anxious to cut again, but arguably it will depend on how the data evolves between now and the October meeting.

Meanwhile, late yesterday afternoon the Central Bank do Brazil cut their SELIC rate by 50bps to 5.50%, a new record low for the rate, but also a widely expected move by the market. Inflation in Brazil continues to slow, and with growth extremely sluggish, President Roberto Campos Neto made clear that they expect inflation to remain quiescent and will do what they can to help bolster the economy there. Look for another 50bps this year and potentially more next year as well. It should be no surprise that the real weakened yesterday, falling 0.8%, and I expect it has further to fall as Neto was clear that a weaker currency would not deter him.

Then overnight we heard from a number of central banks with Bank Indonesia cutting the expected 25bps top 5.25%, while the HKMA also cut in order to keep step with the US. Both currencies, IDR and HKD, were virtually unchanged overnight as the market had fully priced in the moves. Arguably of more importance was the BOJ meeting, where they left policy unchanged, but where Kuroda-san explained that the BOJ would undertake a full review of policy by the October meeting to insure they were doing everything they could to support the economy. There were a number of analysts who were expecting a rate cut, or at least further QE, and so the disappointment led to a 0.5% rally in the yen.

When Europe walked in, there were three central bank meetings scheduled with the Swiss maintaining policy rates but adjusting the amount of reserves exempt from the deposit rate of -0.75%. While Swiss banks have been complaining about this, given there was already a tiered system it was not anticipated that things would change. The upshot is that the franc is firmer by 0.6% in the wake of the announcement, although traders are a bit on edge given the SNB was clear that intervention remained on the table.

The biggest surprise came from Norway, which hiked rates 25 bps to 1.50%. While several of the Norwegian banks were calling for the hike, the market at large did not believe the Norgesbank would raise rates while the rest of the world was cutting. But there you go, the situation there is that the economy is doing fine, inflation is perking up and because of the government’s ability to tap the oil investment fund, they are actually utilizing fiscal policy as well as monetary policy in their economic management. With all that in mind, however, they were pretty clear this is the last hike for the foreseeable future. NOK rallied 0.5% on the news, but it has given all those gains back and now sits unchanged on the day.

Finally, in what is no surprise at all, the BOE just announced that policy remains unchanged for the time being as all eyes turn toward Brexit and what will happen there. The UK also released Retail Sales data which was bang on expectations and so the pound remains beholden entirely to the Brexit situation.

Speaking of Brexit, today is the third day of hearings at the UK Supreme Court regarding the two lawsuits against the Johnson government’s decision to prorogue parliament for five weeks. If you recall, late Tuesday when word got out that the justices seemed to be very hard on the government, the pound rallied. Interestingly, this morning there are stories all over the press about how the likelihood of a no-deal Brexit seems to be growing quickly. Everybody is tired of the process and thus far, neither side has blinked. I maintain the EU will blink as the economic damage to Germany, the Netherlands and Ireland adding to the entire EU’s economic malaise will be too much to tolerate. But we shall see. As I have been typing, the pound has been edging lower and is now down 0.2% on the day, but in the big picture, that is the same as unchanged.

Turning to this morning’s US data, we start with Philly Fed (exp 10.5) and Initial Claims (213K) and then at 10:00 see Existing Home Sales (5.38M). Yesterday’s housing data, starts and permits, were much better than expected, which given the sharp decline in mortgage rates and still robust employment situation, should not be that surprising. As to Fed speakers, there is no one on tap for today, but three (Williams, Rosengren and Kaplan) due to speak tomorrow. Equity futures are pointing slightly lower right now and if I had to guess, the dollar is more likely to rally slightly than not as the day progresses although large moves are not on the cards.

Good luck
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Not Yet Inflated

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Said Chairman Jay, we are frustrated
That prices have not yet inflated
So, patient we’ll be
With rates ‘til we see
More growth than now’s anticipated

The market response was confusing
With stocks up, ere taking a bruising
While Treasuries jumped
The dollar was dumped
And gold found more buyers, it, choosing

Close your eyes for a moment and think back to those bygone days of… December 2018. The market was still giddy over the recent Brexit deal agreed between the UK and the EU. At the same time, hopes ran high that the US-China trade war was set to be defused following a steak dinner in Argentina with President’s Trump and Xi hashing out a delay of tariff increases. And of course, the Fed had just raised the Fed Funds rate 25bps to its current level of 2.50% with plans for two or three more hikes in 2019 as the US economy continued to outperform the rest of the world. Since that time, those three stories have completely dominated the dialog in market and economic circles.

Now, here we are three months later and there has been painfully little progress on the first two stories, while the third one has been flipped on its head. I can only say I won’t be unhappy if another major issue arises, as at least it will help change the topic of conversation. But for now, this is what we’ve got.

So, turning to the Fed, yesterday afternoon, to no one’s surprise, the Fed left policy rates on hold. What was surprising, however, was just how dovish Chairman Powell sounded at the press conference, essentially declaring that there will be no more rate hikes in 2019. He harped on the fact that the Fed has been unable to push inflation to their view of stable, at 2.0%, and are concerned that it has been so long since prices were rising at that pace that they may be losing credibility. (I can assure them they are losing credibility, but not because inflation has remained low. Rather, they should consider the fact that they have ceded monetary policy to the stock market’s gyrations and how that has impacted their credibility. And this has been the case ever since the ‘Maestro’ reacted in October 1987!)

So, after reiterating their current patient stance, markets moved as follows: stocks rallied, bonds rallied, and the dollar fell. Dissecting these moves leads to the following thoughts. First stocks: what were they thinking? The Fed’s patience is based on the fact that the US economy is slowing and that the global economy is slowing even more rapidly. Earnings growth has been diminished and leverage is already through the roof (Corporate debt as %age of GDP is at record levels, above 75%, with more than half of the Investment Grade portion rated BBB, one notch from junk!) Valuations remain extremely high and history has shown that long-term returns from periods of high valuations are de minimus. Granted, by the end of the session, they did give back most of those gains, but it is difficult to see the bull case for equities from current levels given the economic and monetary backdrop. I would argue that all the best news is already in the price.

Next bonds, which rallied to the point where 10-year Treasury yields, at 2.51%, are now at their lowest level since January 2018, and back then, Fed Funds were 100bps lower. So now we have a situation where 3mo T-bills are yielding 2.45% and 10-year T-bonds are yielding 6bps more. This is not a market that is anticipating significant economic growth, rather it is beginning to look like one that is anticipating a recession in the next twelve months. (My own view is less optimistic and that we will see one before 2019 ends.) Finally, the dollar got hammered. This makes sense as, at the margin, with the Fed clearly more dovish than the market had expected, perception of policy differentials narrowed with the dollar on the losing side. So, the 0.6% slide in the broad dollar index should be no surprise. However, until I see strong growth percolating elsewhere, I cannot abandon my view the dollar will remain well supported.

Turning to Brexit, the situation seems to be deteriorating in the final days ahead of the required decision. PM May’s latest gambit to get Parliament to back her bill appears to be failing. She has indicated she will request a 3-month delay, until June 30, but the EU has said they want a shorter one, until May 23 when European parliament elections are to be held (they want the UK out so there will be no voting by UK citizens) or a much longer one so that, get this, the UK can have another referendum to reverse the process and end Brexit. It is remarkable to me that there is so much anxiety over foreign interference in local elections on some issues, but that the EU feels it is totally appropriate to tell the UK they should vote again to overturn their first vote. Hypocrisy is the only constant in politics! With all this, May is in Brussels today to ask for the delay, but it already seems like the EU is going to need to meet again next week as the UK Parliament has not formally agreed to anything except leaving next Friday. Suddenly, the prospect of that happening has added some anxiety to the heretofore smug EU leaders.

Meanwhile, the Old Lady meets today, and there is no chance they do anything. In fact, unless the UK calls off Brexit completely, they will not be tightening policy for years. Slowing growth and low inflation are hardly the recipe for tighter monetary policy. The pound has fallen 0.5% this morning as concerns over the Brexit outcome are growing and its value remains entirely dependent on the final verdict.

As to the trade story, mixed signals continue to emanate from the talks, but the good news is the talks are continuing. I remain more skeptical that there will be a satisfactory resolution but thus far, equity markets, at least, seem to believe that a deal will be signed, and all will be right with the world.

Turning away from these three stories, we have heard from several other central banks, with Brazil leaving the Selic rate on hold at 6.50%, a still historic low, with a statement indicating they are comfortable with this rate given the economic situation there. Currently there is an attempt to get a new pension bill through Congress their which if it succeeds should help reduce long-term debt implications and may open the way for further rate cuts, especially since inflation is below their target band of 4.25%-5.25%, and growth is slowing to 2.0% this year. Failure of this bill, though, could well lead to more turmoil and a much weaker BRL.

Norway raised rates 25bps, as widely expected, as they remain one of the few nations where inflation is actually above target following strong growth throughout the economy. Higher oil prices are helping, but the industrial sector is also growing, and unemployment remains quite low, below 4.0%. The Norgesbank indicated there will be more rate hikes to come this year. It should be no surprise that the krone rallied sharply on the news, rising 0.9% vs. the dollar with the prospect for further gains.

Finally, the Swiss National Bank left rates unchanged at -0.75%, but cut its inflation forecast for 2019 to 0.3% and for 2020 to 0.6%. The downgraded view has reinforced that they will be sidelined on the rates front for a very long time (and they already have the lowest policy rates in the world!) and may well see them increase market intervention going forward. This is especially true in the event of a hard Brexit, where their haven status in Europe is likely to draw significant interest, even with a -0.75% deposit rate.

On the data front today, Philly Fed (exp 4.5) and Initial Claims (225K) are all we’ve got. To my mind, the market will continue to focus on central bank policies, which given central banks’ collective inability to drive the type of economic rebound they seek, will likely lead to government bond support and equity market weakness. And the dollar? Maybe a little lower, but not for long.

Good luck
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