Tag Archives: stocks

Misconstrue

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Ahead of today’s CPI
The markets continue to fly
Though prices keep rising
The pace is surprising-
Ly slower than pundits decry
 
Perhaps now it’s time to review
How old models all misconstrue
The world of today
As their results stray
From outcomes we’re all living through

 

Let’s start with this morning’s CPI data where expectations are for M/M rises of 0.3% for both headline and core readings which translate to 2.7% and 3.0% for the annual numbers.  In both cases, that would be the highest reading since February and will put a crimp in the inflation slowing trend as both the 3-month and 6-month trend data will stop declining.  I assure you that the immediate culprit will be defined as the tariffs, although it is probably still too early to make an accurate reading on that.  Nonetheless, you can be sure that, especially if the bond market sells off, the cacophony will be extreme as to President Trump’s policies are destroying the nation.

Personally, I would disagree with that take.  In fact, something I theorized last week was that a likely impact of the tariffs was that corporate margins would be hit, not necessarily that prices would rise.  Apparently, somebody much smarter than me agrees with that view, a well-respected analyst, @super_macro on X, who made that point this morning.  But all we can do is wait and see the data and response.

Yesterday, as well, I touched on how bond yields around the world were rising which remarkably seems to be a theme in the mainstream media this morning.  I wonder if they’re secretly reading fxpoetry?

Ok, but let’s move on.  I have consistently expressed my view that the current macroeconomic models in use, which are almost entirely Keynesian based, are simply no longer relevant to the world as it currently exists.  I made the point about economic statecraft, as defined by Michael Every (@TheMichaelEvery), the Rabobank analyst who has been far more accurate in his forecasts of likely political outcomes.  Well, in the financial space, another Michael, Green (@profplum99), is also ahead of the pack in my view.  He was on a podcastlast week that is well worth the hour (40 minutes if you listen at 1.5X speed).  

The essence of his work is that the rise in passive investing has had major consequences for equity markets, and by extension other financial markets.  When John Bogle founded Vanguard with the goal of popularizing passive index investing, it represented a tiny fraction of the market and so, its low fees made it an excellent source of capturing market beta unobtrusively.  However, in the ensuing 50 years, and especially in the last 20 when 401K plans were flipped from opt-in to opt-out by government regulation, things have changed dramatically.

This is the most recent chart I can find showing how passive investments (e.g., index funds and target date funds) have grown dramatically in size relative to the overall market (notice the inflection in 2006 when the opt-in regs changed).  In fact, they currently represent about 50% of equity market assets.

The reason this matters is because the term passive is no longer very descriptive of what these funds do.  As Mr Green explains, they work on the following algorithm, if funds flow in, they buy more stocks and if funds flow out they sell them.  Since they are following cap weighted indices, they basically reflect that since funds flow from every 401K into the market throughout every day, they continue to buy the largest stocks (Mag7) out there regardless of any concept of value.  If you think this through, the main factor in the markets is no longer how a company performs, but how many people have jobs where they have some portion of their incomes allocated to 401K plans.  So, as long as people have jobs, and if employment is growing, equity prices have a price-insensitive base of support.  The upshot is equity markets are no longer forward-looking systems, as has been the belief since early financial market theories, but rather they are indicators of the employment situation.  And it is key to remember that the unemployment rate is a lagging macroeconomic indicator

This matters because the Fed, and frankly most major financial institutions and analysts, continue to model the economy with an input from equity markets.  Consider the Index of Leading Economic Indicators, which has the S&P 500 explicitly in the calculation as an example.  Now, if the Fed is looking at models which discount changes in the equity market, clearly a part of their process, it means they are looking in the rear-view mirror.  This is a very cogent explanation as to why the Fed’s models have grown so out of touch with reality, which if you consider how important they are to monetary policy, and by extension the economy as a whole, is quite concerning.  

Concluding, Mr Green has eloquently explained what I have observed over the past months and years, the Fed’s (and most of Wall Street’s) models are simply no longer fit for purpose.  Add to this the concept of fiscal dominance, where government spending overwhelms monetary policy as has been the case for the past several years, and we all can see why the Fed is flying blind.  

With that cheery thought, let’s see how markets are behaving.  Yesterday’s modest US rally was followed by some strength in Asia (Nikkei +0.55%, Hang Seng +1.6%) although mainland shares were unchanged.  Chinese data overnight surprised on the upside regarding GDP, with an annualized outcome of 5.2%, and it saw IP rise 6.8% Y/Y, also better than expected but Retail Sales (4.8%) and Fixed Asset Investment, which is housing driving (2.8%) both disappointed.  The upshot is that domestic demand continues to flag although they have been working hard to export lots of stuff.  The rest of the region saw a very positive day with almost all markets gaining.  In Europe, the picture is more mixed as tariff concerns continue to weigh on nations there with today’s price action a mix of small gains (CAC, DAX) and losses (IBEX, FTSE 100) and nothing more than 0.3%.  US futures, though, are pointing higher at this hour (7:20) by 0.5% or so.

In the bond market, yesterday’s modest rise in yields is seeing a reversal with Treasury yields slipping -1bp, but European sovereigns having a good day with yields down between -5bps and -6bps.  Inflation data from Spain confirmed that the overall inflation situation there is ebbing, and market participants are now pricing one more rate cut by the end of this year which would take the ECB rate down to 1.75%.  As it happens, JGB yields were unchanged overnight, but there is still growing angst over their recent rise.

In the commodity arena, oil (-0.5%) reversed course yesterday and sold off more than $2/bbl as per the below chart.

Source: tradingeconomics.com

This makes more sense to me given the apparent growth in supply, but there seems to be an awful lot of calendar and crack spread activity in the market, most of which I do not understand well enough to describe, but which can impact pricing of the front futures contract.  I would suggest looking on substack at market vibesfor a real education.  I keep trying to learn.  However, from a macro view, I continue to believe that prices have further to decline than rise from current levels.  As to the metals markets, gold (+0.5%) and silver (+0.4%) continue to find consistent support and I see no reason for them to reverse course anytime soon.

Finally, the dollar continues to do very little overall.  For now, the more aggressive downtrend appears to have been halted, as per the chart of the DXY below, but it is hard to get too excited about a significant rebound based on the macro data and interest rate outlook.  The one thing working in the favor of a dollar rebound is the extreme short dollar positions that exist in the hedge fund and CTA communities.

Source: tradingeconomics.com

In addition to the CPI data, we will see the Empire State Manufacturing Index (exp -9.0) and we will hear from four Fed speakers today (Bowman, Barr, Collins and Logan).  Absent a major shock in the CPI data, it strikes me that there is limited reason for any of these speakers to change their personal tune.  So, Bowman is calling for cuts, while the other three have not done so, at least not yet.  In fact, if we start to hear a more dovish take from any of them, that would be news.

And that’s it for this morning.  Market activity is pretty dull overall, and trends remain in place.  Remember, the trend is your friend.

Good luck

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Heartburn

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It seems bond investors are learning
That government spending’s concerning
As yields ‘cross the board
Have all really soared
While buyers become more discerning
 
Meanwhile, o’er the weekend we learned
That Tariff Man’s truly returned
More letters were sent
Designed to foment
Responses as well as heartburn

 

As we approach the middle of the summer, two things are becoming increasingly clear; the world today is very different from just a few years ago and it is getting harder and harder to pay for all the things that the world seems to want.  Taking the second point first, market headlines today have pointed to German 30-year yields which have traded to their highest level since October 2023, and appear set to breech that point and move to levels not seen since prior to the Eurozone bond crisis in 2011 (see MarketWatch chart below)

Similarly, we have seen 30-year yields rise in Japan, a story that gained legs back in late May, and yields overnight returned to those all-time highs from then.

Source: tradingeconomics.com

Not surprisingly, given the debt dynamics globally, US 30-year yields are also pushing back to the levels seen back in May, although have not quite reached those lofty levels and as I type this morning, are trading just below the 5.00% level.

Source: tradingeconomics.com

As Austin Powers might say, “What does it all mean, Basil?”  While I’m just a poet, so take it for what it’s worth, it seems pretty clear that the level of government borrowing is pushing the limits of what private sector investors are willing to absorb.  The below chart, created from FRED data tells an interesting tale.  Up through the GFC, government and private sector debt grew pretty much in step with each other, although after Black Monday in October 1987, government debt started to grow a bit more rapidly.  But the GFC completely changed the conversation and government debt took on a life of its own.  Essentially, the GFC took private losses and nationalized them and put them on the government’s balance sheet. (As an aside, this is why there is still so much anger at the fact that nobody was held accountable for that event, with the perpetrators getting larger bonuses after their banks were bailed out.). But in today’s context, the rise in yields is telling us, or me at least, that the market is losing its appetite for more government debt.

While this is the US graph, the situation is similar around the developed world.  This is why we are hearing more about Secretary Bessent’s sudden love of stablecoins as they will be a source of significant demand for Treasury paper that he needs to sell.  But in the end, do not be surprised if we see more than simply QE, whatever they call it, going forward, but outright financial repression and yield curve control.  While the US may be in the vanguard of this situation, the yields in Germany and Japan tell us that the same is happening there as well.  

As to the first point above, back in the day, it seemed that weekends were observed by one and all around the world with policy statements a weekday affair.  But no longer.  Over the weekend, President Trump sent letters to Mexico and the EU that 30% tariffs were on the way if they did not reach an agreement by August 1st.  For 80 years, most of the Western world operated on a genteel basis, with decorum more important than results.  It is not clear to me if this was because negotiations were more effective, or because most leaders didn’t have the stomach for confrontation.  But it is abundantly clear that President Trump is quite willing to be confrontational with other leaders in order to get his way.  The problem for other leaders is they are not used to dealing in this manner and find themselves uncertain as to how to proceed.  Thus far, whether they have been combative or conciliatory, it doesn’t seem to matter.  Remarkably, it is still just 6 months into this presidency, so things are going to continue to change, but the one thing that is unequivocally true is the world is a different place today than ever before.

Ok, let’s see how other markets are handling the latest tariff storms.  Equity markets are mostly unhappy with this new process as after Friday’s modest declines in the US, we saw more losers (Japan, India, Taiwan, Australia) than winners (Hong Kong, China, Korea) in Asia.  The salient news there was that the Chinese trade surplus grew to $114.8B, slightly more than expected as exports rose sharply while imports underperformed.  However, Chinese bank and lending data did show an increase in M2 and Loan Growth, so at least they are trying to add some monetary stimulus.  As to Europe, other than the UK (+0.4%) the continent is under pressure with Germany (-1.0%) the laggard of the bunch.  The UK story seems to be a single stock, AstraZeneca, which released strong trial results for a new drug.  But otherwise, the tariff story is weighing on the continent.  US futures are also softer at this hour (7:30), down around -0.3% across the board.

While my bond conversation was on the 30-year space, 10-year yields are only marginally higher, about 1bp, in the US and Europe although JGB yields did jump 6bps ahead of their Upper House elections this week. 

In commodities, oil (+1.2%) continues to find support despite the ongoing theme that the economy is soft and supply is growing significantly with OPEC increasing production and set to return even more to the market by the end of the summer.  As it happens, NatGas (+4.75%) is also higher this morning and continues to find substantial support as on a per BTU basis, it is desperately cheap vs. oil, something like one-seventh the price.  In the metals markets, while gold (+0.4%) continues to see support, the real action is in silver (+1.4%) which has rallied very consistently, gapping higher as you can see in the chart below, and has been the subject of much discussion as to how far it can rise.  Historically, silver lags the timing of gold rallies but far outperforms the gains in percentage terms.

Source: finance.yahoo.com

Finally, the dollar is little changed to a touch stronger this morning as traders cannot decide if tariffs are going to be a problem, or if deals are going to be struck.  However, in the dollar’s favor right now is the fact that most other countries are in a clear easing cycle while the Fed remains firmly on hold.  Fed funds futures are pricing less than a 7% chance of a cut this month and only a 61% chance of a September cut.  If US rates continue to run higher than the rest of the world, and there is limited belief they are going to fall, the dollar will find support.  However, given the pressure that President Trump continues to heap on Chairman Powell (there was a story this weekend that Powell is close to resigning, although my take is that is wishful thinking), it is hard to get excited about the dollar’s prospects.  Remember this, all the economists who tell us that an independent central bank is critical work for central banks.

On the data front, after virtually nothing last week, we do get some important numbers this week.

TuesdayCPI0.3% (2.7% Y/Y)
 -ex food & energy0.3% (3.0% Y/Y)
 Empire State Manufacturing-8.0
WednesdayPPI0.2% (2.5% Y/Y)
 -ex food & energy0.2% (2.7% Y/Y)
 IP0.1%
 Capacity Utilization77.4%
 Fed’s Beige Book 
ThursdayInitial Claims234K
 Continuing Claims1970K
 Retail Sales0.1%
 -ex autos0.3%
FridayHousing Starts1.30M
 Building Permits1.39M
 Michigan Sentiment61.4

Source: tradingeconomics.com

In addition to this, we hear from eight FOMC members, so it will be interesting to see if the erstwhile doves are willing to join Waller and Bowman in their call for a July rate cut.  If we start to see momentum build for a July cut, something which is not currently evident, look for the dollar to suffer substantially.  But absent that, I have a feeling we are going to range trade for the rest of the summer.

Good luck

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The World is Aghast

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At one time, not long in the past
New York was a finance dynast
But yesterday’s vote
Does naught to promote
Its future. The world is aghast
 
As well, yesterday, Chairman Jay
Had nothing of note new to say
He’s watching quite keenly
And somewhat serenely
But rate cuts are not on the way

 

I must start this morning on the results from the NYC mayoral primary election where Zohran Kwame Mamdani won the Democratic primary and is now favored to win the general election.  His main rival was former NY state governor, Andrew Cuomo, a flawed man in his own right, but one with the usual political peccadillos (greed, grift and sexual misconduct).  Mamdani, however, is a confirmed socialist whose platform includes rent freezes, city owned grocery stores (to keep costs down) a $30/hour minimum wage (not sure how that will keep grocery prices down) and a much higher tax rate, especially on millionaires.  In addition, he wants to defund the police.  Apparently, his support was from the younger generations which is a testament to the failures of the education system in the US, or at least in NYC.

I mention this because if he does, in fact, become the mayor of NYC, and can enact much of his agenda, the financial markets are going to be interrupted in a far more dire manner than even Covid or 9/11 impacted things.  I expect that we will see a larger and swifter exodus from NYC of both successful people and companies as they seek other places that are friendlier to their needs.

Now, even though he is running as a Democrat, it is not a guarantee that he will win.  Current mayor, Eric Adams is running as an independent, and while many in the city dislike him, he may seem to be a much better choice for those somewhere in the middle of the spectrum.  As well, even if he wins, his ability to enact his agenda is not clear given his inexperience and lack of connections within the city’s power centers. Nonetheless, it is a real risk and one that needs to be monitored closely.  

As to Chairman Powell, as well as the other six FOMC members who spoke yesterday, the generic view is that while policy may currently be slightly tight, claimed to be 25bps to 50bps above neutral across all of them, they are in no hurry to adjust things until they have more clarity regarding the impact of tariffs on inflation and the economy.  They paid lip service to the employment situation, explaining that if things took a turn for the worse there, it would change the calculus, but right now, they’re pretty happy.  It can be no surprise that there were zero deep questions from the Senate committee members, and I expect the same situation this morning when he sits down in front of the House.  

Since the cease fire between Iran and Israel seems to be holding, market participants are now searching for the next catalyst for market movement.  In the meantime, let’s look at how things are behaving.  The “peace’ in the Middle East saw the bulls return with a vengeance yesterday in the US, with solid gains across all major indices, but the follow through was less robust.  While Chinese shares (Hang Seng +1.2%, CSI 300 +1.4%) both fared well, the Nikkei (+0.4%) was less excited and the rest of the region was more in line with Japan than China, mostly modest gains.  From Japan, we heard from BOJ member Naoki Tamura, considered the most hawkish, that raising interest rates was necessary…but not right away.  That message was not very well received.

However, Europe this morning is on the wrong side of the ledger with Spain’s IBEX (-1.25%) leading the way lower although other major bourses are not quite as poorly off with the DAX (-0.4%) and CAC (-0.2%) just drifting down.  NATO is meeting in The Hague, and it appears that they are finalizing a program to spend 5% of respective national GDP’s on defense, a complete turnaround from previous views.  This is, of course, one reason that European bond markets have been under pressure, but I expect it would help at least portions of the equity markets there given more government spending typically ends up in that bucket eventually.  As to US futures, at this hour (7:10) they are little changed to slightly higher.

In the bond market, US Treasury yields continue to slide, down another -1bp this morning and now under 4.30%.  Despite President Trump’s hectoring of Chairman Powell to lower Fed funds, perhaps the fact that Powell has remained firm has encouraged bond investors that he really is fighting inflation.  It’s a theory anyway, although one I’m not sure I believe.  European sovereigns have seen yields edge higher this morning, between 1bp and 2bps as the spending promises continue to weigh on sentiment.  However, even keeping that in mind, after the spike in yields seen in early March when the German’s threw away their debt brake, European yields have essentially gone nowhere.

Source: tradingeconomics.com

While this is the bund chart, all the major European bond markets have tracked one another closely.  Inflation in Europe has fallen more rapidly than in the US and the ECB’s base rate is sitting 200bps below Fed funds, so I suppose this is to be expected.  However, if Europe actually goes through with this massive military spend (Spain has already opted out) I expect yields on the continent to rise.  €1 trillion is a quite significant ask and will have an impact.

Moving to commodity markets, after its dramatic decline yesterday, oil (+0.8%) is bouncing somewhat, but that is only to be expected on a trading basis.  Again, absent the closure of the Strait of Hormuz, I suspect that the supply/demand dynamics are pointing to lower prices going forward, at least from these levels.  In the metals markets, gold (+0.15%) which sold off yesterday as fear abated, is finding its footing while silver (-0.5%) is slipping and copper is unchanged.  It feels like metals markets are looking for more macroeconomic data to help decide if demand is going to grow in the near term or not.  A quick look at the Atlanta Fed’s GDPNow estimates for Q2 show that growth remains quite solid.

Source: atlantafed.org

However, another indicator, the Citi Economic Surprise Index, looks far less promising as it has moved back into negative territory and has been trending lower for the past 9 months.

Source: cbonds.com

At this point, my take is a great deal depends on the outcome of the BBB in Congress and if it can get agreed between the House and Senate and onto President Trump’s desk in a timely manner.  If that does happen, I think we are likely to see sentiment increase, at least in the short term.  That should help all economically sensitive items like commodities.

Finally, the dollar is modestly firmer this morning, rebounding from yesterday’s declines although still trending lower.  The price action this morning is broad based with modest moves everywhere.  The biggest adjustment is in JPY (-0.6%) but otherwise, 0.2% pretty much caps the movement.  Right now, the dollar is not that interesting, although I continue to read a lot about how it is losing its luster as the global reserve currency.  There is an article this morning in Bloomberg explaining how China is trying to take advantage of the current situation to globalize the yuan, but until they open their capital markets, and not just for $50K equivalents, but in toto, it will never be the case.

On the data front, aside from Chair Powell’s House testimony, we see New Home Sales (exp 690K) and then EIA oil inventories with a modest draw expected there.  There are no other Fed speakers and certainly Powell is not going to change his tune.  To my eyes, it is setting up as a very quiet session overall.

Good luck

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Terribly Keen

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The evidence, so far, we’ve seen
Is nobody’s terribly keen
To stop all the shooting
In wars, or the looting
In riots, at least so I glean
 
But can stocks and bonds still maintain
The heights they consistently gain
Or will, one day soon
Risk assets all swoon
As traders turn to their left-brain?

 

I am old enough to remember when Israel’s attack on Iranian nuclear facilities was considered a risk to global financial assets.  Equity prices fell around the world as investors scrambled to find havens to protect their assets.  Alas, these days, the only haven around seems to be gold as Treasury yields, after an initial slide, rebounded which implies investors may have questioned their safety and the dollar, after a slight bump, slipped back.

But that is clearly old-fashioned thinking as evidenced by the fact that fear is already ebbing in markets with equities rebounding this morning, the dollar under pressure and both gold and oil slipping slightly.  Now, it is early days but a look at the chart below of oil shows that it took about 9 months for oil prices to retrace to their pre-Russia invasion levels.  Obviously, this situation is different than that from the perspective that prior to Russia’s invasion, there were no energy market sanctions while Iran has been subject to sanctions for years.  However, the larger point is that the market, at least right now, seems to have adjusted to what it believes is the appropriate level to account for changes in production.

Source: tradingeconomics.com

Now, as of January 2025, at least as per the data I could find, Russia produces 10.7 million barrels/day while Iran clocks in at just under 4 million.  As well, given the sanctions, much of Iran’s production has a limited market, with China being the largest importer.  I’m simply trying to highlight that Russia’s production was much larger and more critical to the oil market overall, so a larger impact would be expected.  However, the fact that Israel continues to destroy Iranian infrastructure, and has targeted oil infrastructure as well as nuclear infrastructure, suggests there could easily be more impacts to come.  This is especially true if Iran seeks to close the Strait of Hormuz, a key bottleneck exiting the Persian Gulf and where some 20% of global oil production transits daily.

But the market is sanguine about these risks, at least for now.  There is no indication that Israel has completed what they see as their mission, and that means things could well escalate from here.  In that case, I would expect another jump in oil prices, but overall, it is not hard to believe that we have seen the bulk of any movement.  It strikes me that we will need substantially stronger economic activity to push oil prices much higher from here, and that seems unlikely right now.

Meanwhile, near Banff there’s a meeting
Where heads of state are all competing
To help convince Trump
There will be a slump
Unless tariff pressures are fleeting

The other noteworthy story this morning is the G-7 meeting that is being held in Kananaskis, Alberta, near Calgary and Banff and how all the other members of the club, as well as invitees from Mexico, Brazil, South Africa, India and South Korea, will be trying to convince the president that his tariffs are going to be too damaging and need to be adjusted or removed, at least for their own nations.

Anyone who indicates they know how things will evolve is offering misinformation as Trump’s mercurial nature precludes that from being the case.  However, it would not be inconceivable for some headway to be made by some of these nations in certain areas although President Trump does appear to strongly believe tariffs are a benefit by themselves.  I am not counting on any major breakthroughs here, but small victories are possible.

One last thing before the market recap though, and this was a Substack piece I read this weekend from The Brawl Street Journal, that, frankly, shocked and scared me regarding the ECB and some plans they are considering.  While President Trump has consistently called the climate hysteria a hoax and his administration is doing everything it can to remove Net Zero promises and CO2 reduction from anything the government does, the opposite is the case in Europe.  The frightening part is that the ECB is considering adding effective mandates to lending criteria such that loans to support agriculture or fossil fuel production will require banks to hold more capital, making them more expensive.  The very obvious result is there will be less loans in this space, and things like agriculture and fossil fuel production will become scarcer in Europe than elsewhere.  

Yes, this is suicidal, but then we have already seen Germany (and the UK) attempt to commit economic suicide with its energy policy, and while many in Europe would suffer the consequences, I assure you the members of the ECB would not be in that group.  But my point, overall, is that if this plan is enacted, and the target date appears to be this autumn, it is a cogent reason for the euro to begin a structural decline to much lower levels.  This is not for today, but something to remember if you hear that the NVaR (Nature Value at Risk) plan is enacted.  Tariffs will be their last concern as the continent enters a long-term economic decline as a result.  The blackout in Spain in April will become the norm, not the unusual circumstance.

Ok, let’s see how little investors are concerned about war and escalation.  While equity markets were lower around the world on Friday, that is just not the case anymore.  Asia saw the Nikkei (+1.3%) lead the way higher with the Hang Seng (+0.7%) and CSI 300 (+0.25%) also gaining as well as strength in Korea (+1.8%) and India (+0.8%) as hopes rise some positive news will come from the G-7.  Europe, too, has seen gains across the board led by Spain (+0.9%) and France (+0.7%) with most other markets rising between 0.3% and 0.5%.  As to US futures, at this hour (6:50) they are higher by about 0.5% with the NASDAQ leading the way.

In the bond market, Treasury yields are backing up a further 3bps this morning but are still just above 4.40%.  European yields are +/- 1bp across the board as investors try to decipher ECB commentary about the next rate move.  The universal belief is there will be another cut, although Bundesbank president Nagel tried to pour cold water on that thesis this morning calling for caution and a meeting-by-meeting approach going forward.

Commodity markets, are of course, the real surprise this morning with oil (-1.1%) looking like it has put in at least a short-term top.  In the metals market, gold (-0.4%) is giving back some of last week’s gains although both silver (+0.2%) and copper (+1.1%) are rebounding after tougher weeks.  Metals prices seem to be pointing to less fear and more hope for economic rebound.

Finally, the dollar is under some pressure this morning, slipping vs. most of its counterparts in both the G10 and EMG blocs.  The euro (+0.25%) is having a solid session although both AUD (+0.4%) and NZD (+0.5%) are leading the G10 pack.   Even NOK (+0.1%) is rallying despite oil’s pullback.  In the EMG bloc, ZAR (+0.8%) is the leader right now, partially on continued gains in platinum and gold’s overall recent performance, and partially on hopes that their presence at the G-7 will get them some tariff relief.  Elsewhere, the gains have been less impressive with KRW (+0.5%) also benefitting from tariff hopes while the CE4 see gains of 0.3% or so.  No tariff hopes there.

It is an important data week with Retail Sales and housing data, but also because the FOMC leads a series of central bank decisions.

TodayEmpire State Manufacturing-5.5
TuesdayBOJ Rate Decision0.50% (no change)
 Retail Sales-0.7%
 -ex autos0.1%
 IP0.1%
 Capacity Utilization77.7%
WednesdayRiksbank Rate Decision2.0% (-25bps)
 Housing Starts1.36M
 Building Permits1.43M
 Initial Claims245K
 Continuing Claims1940K
 FOMC Rate Decision4.5% (no change)
ThursdaySNB Rate Decision0.00% (-25bps)
 BOE Rate Decision4.25% (no change)
FridayPhilly Fed-1.0

Source: tradingeconomics.com

So, Sweden and Switzerland are set to cut rates again, while the rest of the world waits.  Chairman Powell’s comments seem unlikely to stray from the concept of too much uncertainty given current fiscal policies so no need to do anything.  Thursday is a Federal holiday, Juneteenth, hence the early release of Claims data.  I have to say the Claims data is starting to look a bit worse with the trend clearly climbing of late as per the below chart.

Source: tradingeconomics.com

I continue to read stories about the cracks in the labor market and how it will eventually show itself as weaker US economic activity, but the process has certainly taken longer to evolve than many analysts had forecast.  One other thing to remember is that Congress is still working on the BBB which if/when passed is likely to help support the economy overall.  The target date there is July 4th, but we shall see.

Summarizing the overall situation, many things make no sense at all, and others make only little sense, at least based on more historical correlations and relationships.  I think there is a real risk of another sell-off in risk assets, but I do not see a major collapse.  As to the dollar, the trend remains lower, but it is a slow trend.

Good luck

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Need Some Revising

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The punditry fears that the bond
Is starting to move far beyond
A level at which
The US can stitch
Together a plan to respond
 
Meanwhile, though yields broadly are rising
The dollar, it’s somewhat surprising
Continues to sink
Which makes some folks think
Their models now need some revising

 

Perspective is an important thing to maintain when looking at markets as it is far too easy to get wrapped up in the short-term blips within a trend and accord them more importance than they’re due.  It is with that in mind that I offer the below chart of the 10-year US Treasury yield for the past 40 years.

Source: finance.yahoo.com

Lately, much has been made of the fact that 10-year yields have risen all the way back to where they were on…January 1st of this year.  But the long history of the bond market is that yields at 4.5% or so, which is their current level, is the norm, not the exception.  As you can see, in fact they were far higher for a long time.  Now, I grant that the amount of debt outstanding is an important piece of the puzzle when analyzing the risk in bonds, and the current situation is significant.  After all, even Moody’s finally figured out that the US’s debt metrics were lousy.  And under no circumstances am I suggesting that the fiscal situation in the US is optimal. 

But I also know that, as I wrote yesterday, the Fed is not going to allow the bond market to collapse no matter their view of President Trump.  Neither is the US going to default on its debt (beyond the slow pain of higher inflation) during any of our lifetimes.  I continue to read that the just-passed ‘Big, Beautiful Bill’ is going to result in deficits of 7% or more for the next decade, at least according to the CBO.  Alas, predicting the future is hard, and no one knows that better than the CBO.  Their track record is less than stellar on both sides of the equation, revenues and expenditures.  This is not to blame them, I’m sure they are doing their best, it is just an impossible task to create an accurate forecast of something with so many moving parts that additionally relies on human responses.

My point is that one needs to look at these forecasts with at least a few grains of salt.  While the current narrative is convinced that deficits are going to blow out and the nation’s finances are going to fall over the edge of the abyss, while the trend is in the wrong direction, my take is the end is a long way off.  In fact, the most likely outcome will be debt monetization around the world, as every government has borrowed more than they are capable of repaying without monetizing the debt.  The real question we need to answer is which nations will be able to do the best job of managing the situation on a relative basis.  And that, my friends, despite everything you read and hear about, is still likely to be the US.  This is not to say that US assets will not fall out of favor for a while relative to their recent behaviors, just that in the long run, no other nation has the resources and capabilities to thrive regardless of the future state of the world.

I guess the one caveat here would be that the entire global framework changes as the fourth turning evolves and old institutions die while new ones are formed.  So, the end of the IMF and World Bank, the end of SDR’s and even organizations like the UN cannot be ruled out.  And I have no idea what will replace them.  Regional accords may become the norm, CBDC’s may become the new money, and AI may run large swaths of both governments and the economy.  But in the end, at least nominally, government debt will be repaid in every G10 nation, of that I am confident.

One of the reasons I have waxed philosophical again is that market activity, despite all the chattering of the punditry, remains pretty dull.  For instance, in the bond market, despite all the talk, Treasury yields, after slipping a few bps yesterday, are unchanged today.  The same is true across Europe, with no sovereign bond having seen yields move by more than 1 basis point in either direction.  JGB’s overnight, despite CPI coming in a tick hotter than forecast, saw yields slip -4bps, following the US market from yesterday.  If the end is nigh, the bond market doesn’t see it yet.

In equities, yesterday’s lackluster session in the US was followed by a lackluster session in Asia (Nikkei +0.5%, CSI 300 -0.8%, Hang Seng +0.25%) with no overall direction and this morning in Europe, the movement has been even less interesting (CAC -0.5%, DAX +0.2%, FTSE 100 0.0%). Too, US futures are little changed at this hour (7:00).

In the commodity markets, gold (+0.9%) continues to chop around within a range that it entered back in early April.

Source: tradingeconomics.com

To me, this is the perfect encapsulation of all markets, hovering near recent highs, but unable to find a catalyst to either reject those highs, or leave them behind in a new paradigm.  You won’t be surprised that other metals are also a touch higher this morning (Ag +0.2%, Cu +0.7%), nor that oil (+0.3%) is also edging higher.  It strikes me that today’s commodity profile may be attributed to the dollar’s weakness.

So lastly, turning to the dollar, it is softer against virtually all its major counterparts this morning, with the euro (+0.6%) and pound (+0.6%) both having a good day.  In fact, the pound has touched 1.35 for the first time in three years.  But the dollar’s softness is widespread in both blocks; G10 (AUD +0.85%, NZD +1.0%, SEK +1.0%. NOK +1.0%, JPY +0.5% and even CAD +0.35%), and EMG (ZAR +0.7%, PLN +0.6%, KRW +1.0%, SGD +0.5% and CNY +0.35%).  The fact that SGD moved 0.5% is remarkable given its inherently low volatility.  But I assure you, Secretary Bessent is not upset with this outcome.

The only data this morning is New Home Sales (exp 692K) and we hear from yet another Fed speaker this afternoon, Governor Cook.  Chairman Powell will be speaking on Sunday afternoon, so that may set things up for next week, although with the holiday weekend, whatever he says is likely to be diluted by the time US markets get back to their desks on Tuesday.

In the end, the message is the end is not nigh, markets are adjusting to the changing realities of trade and fiscal policies, and monetary policies remain on a steady state.  The ECB is going to cut again, as will the BOE.  The BOJ is likely to hike again, and the Fed is going to sit on its hands for as long as possible.  The futures market is still pricing in two rate cuts this year, but I still don’t see that happening.  In fact, if the tax bill is enacted, I suspect that it will have a significantly positive impact on the economy, as well as on expectations for the economy, and interest rates are unlikely to fall much at all.  As well, absent a concerted international effort to weaken the dollar (those pesky Mar-a-Lago accords again), while the short-term direction of the dollar is lower, I’m not sure how long that will continue.  

Good luck and have a great holiday weekend

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Has Bug Met Windshield?

Posted on by

So, once again, we were misled
By all those who told us, with dread,
The ratings reduction
Would cause much destruction
With both stocks and bonds, money, dead
 
Instead, what we saw yesterday
Was traders jumped into the fray
Despite all the gloom
It seems there’s still room
Where bullish investors hold sway

 

I know it is hard to believe, but it seems that all the angst that was fomented over the weekend following Moody’s ratings downgrade of US Treasury debt was for naught.  In fact, the decline in both stocks and bonds didn’t even last one session, let alone weeks or months as both markets closed the session essentially unchanged on the day, recouping the early losses seen.  A quick look at the chart below shows the price action in S&P 500 futures from the time of the announcement through yesterday’s close and then this morning.  It seems the market is concerned about things other than the US credit rating.

Source: tradingeconomics.com

In fact, I am willing to say that we are unlikely to hear anything more about the downgrade until such time that equity prices fall on some other catalyst, and the punditry will add in the ratings story to help bolster whatever claim they are making at that time.  Please remember, as well, that I am quite concerned that equity valuations remain rich and that a decline is quite possible, if not likely.  It’s just that the ratings downgrade story is not going to be the driver of that move.

In Japan, it seems
No one’s buying JGBs
Has bug met windshield?

Last night, Japan auctioned 20-year JGBs with the yield coming at 2.52%, the highest since these bonds were first issued back in 1999.  As well, yields in 30-year and 40-year JGBs also soared, rising 12bps in each case to the highest yield in more than 25 years as per the below chart of the 30-year bond.

While the selloff in JGBs has been accelerating, real yields there are still negative with CPI running at 3.6%.  This presents quite a conundrum for Japanese investors as despite the negative real yield, the ability to borrow cheaply (remember short term rates in Japan are 0.50%) and invest in long-dated bonds and earn 3.0% is quite tempting.  250 basis points of carry with no currency risk is now going to compete with 450 basis points of carry (US 30-year yields of ~5.0% – 0.50% funding costs in Japan) with FX risk.

What makes this especially tricky for Japanese investors is that the dollar’s future path, which had been clearly higher for longer, appears to have adjusted.  It seems evident the Trump administration is keen to see the dollar decline, or perhaps more accurately, see other currencies appreciate, especially if those nations run significant trade surpluses with the US.  Japan certainly fits that bill.  And the thing about currency risk is that FX can move swiftly enough to wipe out any carry benefits before institutional investors can even organize meetings to determine if they want to change their strategy.

One of the things that we have heard regularly for the past several years (decades?) is that the US fiscal situation has put the nation in a precarious position, relying on investment by foreigners to fund the massive budget deficits that the government has been running.  The problem with these warnings is they have been ongoing for so long, nobody really pays them any attention.  It is not to say the theory is incorrect, just that there have been other things that have offset that factor and attracted capital to the US anyway.  It is also not apparent that Moody’s ratings cut has changed that dynamic.

But, if at the margin, Japanese investors start to focus more on the JGB market to reduce currency risk, rather than on the highest yield available in major nations, that would likely have a negative impact on the Treasury market.  That is, of course, a big IF and there is no evidence yet that is the situation.  It is something, though, we must watch closely.  

Remember, too, global debt/GDP is more than 300% across all types of debt, public and private.  That tells me it will never be repaid, only rolled over.  The question is at what point will investors decide that holding debt is too great a risk at current yields?  While I assure you governments around the world will work hard to prevent that outcome, including changing regulations to force purchases, it is not clear how much higher that ratio can go without more seriously negative consequences.  We will need to watch this closely.

With that in mind, let’s turn to markets and see how things have behaved in the wake of the reversal in US markets yesterday.  Asian equities were mixed with Japan essentially unchanged, China (+0.5%) and Hong Kong (+1.5%) showing the best performance in the region while India (-1.0%) was the laggard.  Otherwise, there were both gainers and losers of limited note.  In Europe, though, equity markets are rallying across the board led by Spain’s IBEX (+1.6%) despite another infrastructure disaster where half the nation lost telecoms for several hours as Telefonica (Spain’s major telecom company) messed up a systems upgrade.  The rest of the continent has seen shares rise on the order of 0.4% to 0.5% as ECB comments seem to be encouraging the idea of another rate cut coming soon and European Current Account data showed a greater surplus than expected.  US futures, though, are ever so slightly lower at this hour (7:15), down about -0.1% across the board.

In the bond market, in the 10-year space, yields are within 1bp of yesterday’s closing for Treasuries (+1bp), European sovereigns (-1bp) and JGBs (+1bp).  It seems that despite all the talk of the end of times, investors haven’t given up yet, at least not in the 10yr space.  However, the evidence is growing that fixed income investors are growing leery of tenors longer than that.

In the commodity markets, oil (-0.6%) is slightly softer but remains well within its recent trading range amid the slightest of downtrends.  In truth, I find this chart to be an excellent description of my feelings of this market, a really slow decline over time.

Source: tradingeconomics.com

As to the metals markets, gold (+0.6%) is continuing its rebound from the worst levels seen last Thursday and is currently more than $100/oz higher than those recent lows.  This has helped silver (+0.5%) as well although copper (-0.5%) is not playing along today.

Finally, the dollar, remarkably, did not collapse in the wake of the Moody’s downgrade.  In fact, similar to the price action in both stocks and bonds yesterday, the dollar retraced much of its early losses.  This morning, it remains on the soft side, but movement is much less pronounced across both the G10 and EMG blocs.  However, the worst performer today is AUD (-0.7%) which some may attribute to the fact that the RBA cut their base rate by 25bps last night (although that was widely expected).  But I would point to the law that was recently enacted by the Albanese government in Australia to begin taxing UNREALIZED capital gains.  This idea has been floated by other governments but never actually enacted.  I fear that the consequences for Australia will be dire as it becomes clear the policy is extraordinarily destructive.  Capital will flee and that bodes ill for the currency.  If they truly follow through with this, be very careful.

There is no data today, but we hear from six different Fed speakers as they are all participating in an Atlanta Fed symposium.  However, I do not expect anything other than patience is the watchword as they observe the Trump administration policies unfold.

In the end, the predicted doom did not come to pass.  However, for my money, I would pay closest attention to Australia.  I fear the negative consequences of this policy will be extreme.

Good luck

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Set Cash On Fire

Posted on by

On Friday, the Moody’s brain trust
At last said it’s time to adjust
America’s debt
As we start to fret
That it’s too large and might combust
 
So, Treasury yields are now higher
As pundits explain things are dire
But elsewhere, as well
Seems bonds are a sell
As governments set cash on fire

 

Arguably, the biggest story of the weekend happened late Friday evening as Moody’s became the third, and final, ratings agency to downgrade US government debt to Aa1 from Aaa.  S&P did the deed back in 2011 and Fitch in 2023.  The weekend was filled with analyses of the two prior incidents and how markets responded to both of those while trying to analogize those moves to today.  In a nutshell, the first move in both 2011 and 2023 was for stocks to fall and bonds to rally with the dollar falling. However, in both of those instances, those initial moves reversed over the course of the ensuing months such that within a year, markets had pretty much reversed those moves, and in some cases significantly outperformed, the situation prior to the downgrade.  

Looking at Moody’s press release, they were careful to blame this on successive US administrations, so not putting the entire blame on President Trump, but in the end, it is hard to ignore that the nation’s fiscal statistics regarding debt/GDP and debt coverage are substantially worse than that of other nations that maintain a Aaa rating.  As well, their underlying assumption is that there will be no changes in the current trajectory of deficits and so no reason to believe things can change.

The most popular weekend game was to try to estimate how things would play out this time although given the starting conditions are so different in the economy, I would contend past performance is no guarantee of future outcomes.  In this poet’s eyes, it is not clear to me that it will have a long-term material impact on any market.  We have already been hearing a great deal about how Treasuries are no longer the safe haven they were in the past.  I guarantee you that institutions looking for a haven were not relying solely on Moody’s Aaa rating for comfort.  In addition, given a key demand for Treasuries is as collateral in the financial markets, and the Aa1 rating is just as effective as a Aaa rating from a regulatory risk perspective, I see no changes coming

As to equities, I see no substantive impact on the horizon.  The equity market remains over richly valued and if it were to decline, I don’t think fingers could point to this action.  Finally, the dollar has been declining since the beginning of the year and remains in a downtrend.  Using the DXY as our proxy, if the dollar falls further, should we really be surprised?

source tradingeconomics.com

To summarize, expect lots more hyperbole on the subject, especially as many analysts and pundits will try to paint this as a failure of the Trump administration.  And while bond yields may rise further, as they are this morning, given the fact that yields are rising everywhere around the world, despite no other nations being downgraded, this is clearly not the only driver.

In fact, one could make the case that bond yields are rising around the world because, like the US, nations all over are talking about adding fiscal stimulus to their policy mix.  After all, have we not been assured that Europe is going to borrow €1 trillion or more to rearm themselves?  That is not coming out of tax revenue, that is a pure addition to the debt load.  As well, is not a key part of the ‘US will suffer more than China in the tariff wars’ story based on the idea that China will stimulate the domestic economy and increase consumption (more on that below)?  That, too, will be increased borrowing.  I might go so far as to say that the increased borrowing globally to increase fiscal stimulus will lead to higher nominal GDP growth everywhere along with higher inflation.  I guess we will all learn how things play out together. 

Ok, so now that we have a sense of THE big story, let’s see how markets behaved elsewhere.  I thought that today, particularly, it would be useful to see how bond markets around the world have behaved in the wake of the Moody’s news.  Below is a screenshot from Bloomberg this morning.  note that every major market that is open has seen bonds sell off and I’m pretty confident that Canada’s at the very least, will do so when they wake up.  Ironically, the European commission came out this morning and reduced their forecasts for GDP growth and inflation this year and next and still European sovereign yields are higher.  I have a feeling that this news is not as impactful as some would have you believe.

Turning to equity markets, Friday’s US rally is ancient history given the change in the narrative.  And as you can see below from the tradingeconomics.com page, every major market is softer this morning (those are US futures) with only Russia’s MOEX rising, hardly a major market.  Again, it appears the fallout from the ratings cut is either far more widespread, or not a part of the picture at all.  It seems you could make the case that if European growth is going to underperform previous expectations, equity markets there should underperform as well.  The other two green arrows are Canada and Mexico, neither of which is open as of 6:30 this morning.

Commodity markets are the ones that make the most sense this morning as oil (-1.3%) is under pressure, arguably on a weaker demand picture after softer Chinese data was released overnight.  While the timing of the impacts of the trade war is unsettled, there is certainly no evidence that China is aggressively stimulating its economy.  This was very clear from the decline in Retail Sales, Fixed Asset Investment and IP, although the latter at least beat expectations.  But the idea that China is changing the nature of their economy to a more consumption focused one is not yet evident.  Meanwhile, metals markets are all firmer this morning with gold (+1.2%) leading the way, arguably as a response to the ratings downgrade.  This has dragged both silver (+0.9%) and copper (+1.0%) along for the ride.  It is not hard to imagine that sovereign investors see the merit in owning storable commodities like metals in lieu of Treasuries, at least at the margin.  But also, given the dollar’s weakness, a rally in metals is not surprise.

Speaking of the dollar’s weakness, that is the strong theme of the day along with higher yields across the board.  Right now, the euro (+1.0%) and SEK (+1.0%) are leading the way higher although the pound (+0.9%) is also doing well.  Perhaps this has to do with the trade agreement signed between the UK and EU reversing some of the Brexit outcomes at least regarding food and fishing, although not regarding regulations or immigration.  JPY (+0.6%) is also rallying as is KRW (+0.75%) and THB (+0.9%) as there is a continuing narrative that stronger Asian currencies will be part of the trade negotiations.  Finally, Eastern European currencies are having a good day (RON +2.3%, HUF +1.8%, CZK +1.2%, PLN +1.0%) after the Romanians finally elected a president that was approved by the EU.  Yes, they had to nullify the first election and then ban that candidate from running again, but this is how democracy works!

On the data front, there is very little hard data to be released this week, although it appears every member of the FOMC will be on the tape ahead of the Memorial Day weekend.  Perhaps they are starting to feel ignored and want to get their message out more aggressively.

TodayLeading Indicators-0.9%
ThursdayInitial Claims230K
 Continuing Claims1890K
 Flash Manufacturing PMI50.5
 Flash Services PMI51.5
 Existing Home Sales4.1M
FridayNew Home Sales690K

Source: tradingeconomics.com

Actually, as I count, there are three members, Barr, Bowman and Waller who will not be speaking this week, although Chairman Powell doesn’t speak until next Sunday afternoon.  In the end, the narrative is going to focus on the ratings cut for a little while, at least for as long as equity markets are under pressure along with the dollar.  However, when that turns, and I am sure it will, there will be a search for the next big thing.  I have not forgotten about the potential large-scale changes I discussed on Friday, and I am still trying to work potential scenarios out there, but for now, that is not the markets’ focus.  Certainly, for now, I see no reason for the dollar to gain much strength.

Good luck

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This is the End

Posted on by

Apparently, this is the end
So says every article penned
The markets are tanking
But nobody’s banking
On help to arrest the downtrend
 
The pundits’ unanimous line
Is things before Trump were just fine
Yes, debt was insane
But that gravy train
Allowed them to drink the best wine

 

Every financial website lead this morning is how President Trump’s policies are causing the worst slide in equity prices in forever, with my favorite today in the WSJ describing this as the worst performance in April since 1932!  Much has been made about how President Trump is undermining the Fed’s credibility, as though the Fed has that much credibility to undermine.  This is the group that declared stable prices to be an increase in their favored indicator, core PCE, of 2.0% annually, and complained vociferously when inflation was slightly below that level for a decade.  In order to adjust things, they changed their target to an average of 2.0% over time, then watched their metrics, in the wake of the Covid fiscal response, explode higher.  Now, after more than four years of their target metric above their target, they are concerned they are losing their credibility because of President Trump.  

Source: tradingeconomics.com

Certainly, if they had been achieving their goals any time during the past four years, this argument might have had some force.  However, given the history, I am suspect.

Nonetheless, this is today’s narrative, that equity markets are falling sharply because of Trump.  It has nothing to do with the fact that US equity markets have been overvalued by nearly every measure since November 2012, (the last time the S&P 500 P/E ratio was at its mean of 16.14 vs today’s still very high 25.64).  This is not to say that the president’s tactics have necessarily been the best possible, but we have all long known that a catalyst would come along and adjust prices to a more sustainable level.  

Source: multpl.com

Once again, I will highlight that President Trump was elected with a mandate to make substantial changes to the way things work in the US, both the economy and other issues like immigration.  Remember, too, that many of his supporters are not heavily invested in equity markets, so this is not really a problem for them.  I believe he can tolerate a lot more downside in equity prices before feeling it necessary to address them.  And if he is successful in signing some trade deals during his 90-day time frame, I expect that things will calm down quite quickly.

But right now, investors are very unhappy, and since virtually everyone in the media is an investor, we are going to hear a lot more on this topic, especially since they almost certainly didn’t vote for President Trump.

Here’s the thing about markets, overvaluations correct over time.  In fact, often they result in under valuations as markets tend to overshoot in both directions.  However, you have probably heard of the Buffett Indicator, which is Warren Buffett’s shorthand way of determining stock valuations.  He simply divides the total market capitlaization of US equities by GDP.  His view is that when that ratio is between 110% and 130%, equity markets are fairly valued.  Below that, things are cheap, and it is a good time to buy stocks.  Above that, like today, and good values are hard to find.  You are also probably aware that Berkshire Hathaway is currently holding its largest cash position ever, a sign that he still thinks things are overvalued.  One need only look at the below chart to see that while the recent decline in stocks has brought the indicator lower, its current level of 173% remains extremely overvalued.

Source: buffettindicator.net

All I am trying to do is offer some perspective on the recent movement.  Risk appetite was over extended while the US ran 7% budget deficits and issued a massive amount of debt to fund it.  Much of that funding went into risk assets.  That situation has clearly changed, or at least that is the goal of the Trump administration.  It is a painful transition, but likely one that we need to absorb for longer term fiscal and economic health.

Ok, let’s see how market behaved overnight, after a rout in the US yesterday, now that everybody is back at their desks.  Major Asian markets were very quiet, with limited movement in Japan, China, Korea, Australia and India, although we did see sharp declines in Taiwan (-1.6%) and New Zealand (-2.25%) with the latter seeming to be one of the few markets tracking the US directly.  The only news there was a larger than expected trade surplus, which doesn’t seem the type of thing to cause a sell-off.  Meanwhile, in Europe, there is also little net movement with a couple of modest gainers (Spain, UK) and a couple of modest laggards (France Germany) with everything trading less than 0.5% different than their last closes.  Interestingly, US futures are all higher by about 1.0% at this hour (7:05).

In the bond market, this morning is quiet everywhere with movements of +/-1bp the norm although yesterday did see Treasury yields climb 6bps in the session.  Something that is starting to move in fixed income markets are credit spreads, which have been abnormally tight for a long time and may be starting to widen out to previous historical levels.  If spreads start to widen, that will not help equity markets at all, and that could be the signal that policy adjustments are coming, both from the administration and the Fed.  We will keep an eye here.

In the commodity markets, nothing is stopping the gold train, up another 0.7% this morning to another new high.  This movement is parabolic and that cannot last very long.  Beware of a correction.  

source: tradingeconomics.com

In the meantime, silver (-0.2%) and copper (+0.5%) are still hanging around, but without the same panache as gold.  In the oil market, WTI (+1.3%) has rebounded from yesterday’s decline as the latest stories are that capex by the oil majors is going to decline and with it, we will see a reduction in supply, hence higher prices.  On the flip side, if a deal with Iran is signed and their oil comes back on the market freely, that will weigh on prices for at least a while.

Finally, the dollar, which along with equities, has been sold aggressively of late, is bouncing slightly this morning.  This story remains perfectly logical as one of the reasons the dollar had been so strong was foreign investors bought dollars to buy the Mag7 and US equities in general.  With US equities weakening, these foreigners are likely to start to sell more and take their money home, or elsewhere, but nonetheless, they don’t need those dollars.  Certainly nothing has changed my bearish view here with today’s gains a modest correction.  There are two outliers this morning, with MXN (+0.6%) and ZAR (+0.5%) the only currencies of note rallying against the greenback, both seemingly following the commodity rally.

On the data front, there is nothing noteworthy this morning, but a bit of data later in the week.

WednesdayFlash Manufacturing PMI49.4
 Flash Services PMI52.8
 New Home Sales680K
 Fed’s Beige Book 
ThursdayInitial Claims221K
 Continuing Claims1880K
 Durable Goods2.0%
 -ex Transport0.2%
 Existing Home Sales4.13M
FridayMichigan Sentiment50.8
 Michigan Inflation Expected6.7%

Source: tradingeconomics.com

In addition, we have 7 Fed speakers over 8 venues this week, with four of them today.  However, it is not clear that they have much impact these days.  Expectations for a cut next month are down to 9% although the market is pricing 90bps of cuts this year.  But, once President Trump started implementing his policies, the Fed slipped into the shadows.  It is interesting that there are questions about the Fed’s credibility as lately, nobody has listened to them anyway.  I don’t expect anything other than patience from them for now as they await the “inevitable” decline in the economy.  However, until the data really starts to show something, and there is nothing forecast in this week’s releases, that points to economic weakness of note, they are on the sidelines.

Overall, I expect more volatility in risk assets, and I do believe the trend for foreign investors to reduce their exposure to the US will continue.  That, too, will weigh on the dollar.  Maybe not today, but another 10% this year is quite viable.

Good luck

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Likely to Bleed

Posted on by

By now, everyone is aware
The world we had known is not there
While populist views
Are turning the screws
On governments ‘bout everywhere
 
The upshot is capital’s lead
O’er labor is like to recede
So, wages will rise
With yields, and surprise
Risk assets are likely to bleed

 

For the first time in quite a few sessions, certainly since ‘Liberation Day’, market activity has calmed down a bit.  It is not that markets have stopped moving, just that the wild gyrations have disappeared for the moment.  I would estimate that for most investors, and certainly for risk managers with hedging requirements, this is a blessing.  However, for the trading desks at Wall Street firms, maybe not so much.  I couldn’t help but notice the lead headline in the WSJ this morning, “Bank Trading Desks Are Minting Money From Tariff Chaos”  

Now, we cannot be surprised by this, as volatile markets are what traders, especially bank traders with customer flow, live for.  This is where they truly have an edge, even over the algos, because they have information the algos don’t have, the order flow.  This got me to thinking about the idea, one which I have embraced, that President Trump is concerned with Main Street, not Wall Street.  Well, if Wall Street is going to play second fiddle, I’m sure many there are perfectly comfortable with this situation.  Arguably, if this continues, we are going to see many internecine battles at the big Investment Banks as traders gain power at the expense of bankers, but the firms overall will be just fine.  (I know you were all worried 🤣.)

But let’s go back to the Main Street, Wall Street question.  Someone who I have been following on Substack, Russell Clark, a UK hedge fund manager, has described this point very well.  In the battle between labor and capital for corporate resources, Wall Street benefits when capital is favored by legislation/regulation while Main Street benefits when the rules turn in labor’s favor.  

For the past 25 years, the rules have been helping capital at labor’s expense.  Especially since the GFC, when the financialization of the economy really took off, this has been the case.  Just look at the extraordinary rise in corporate profits during this period compared to the long history.  This is a direct result of the globalization effort, with the outsourcing of much manufacturing to China and other low-wage nations.

Source: fred.stlouisfed.org

But let us consider what we have seen fomenting for the past decade, arguably since President Trump’s first election and Brexit occurred in 2016.  Those were populist outcomes.  And we have seen populism rise around the world.  It is couched as right-wing fascism by many in the media, but whether in Germany, France, Italy, the Netherlands, here in the US or many other Western nations, the people’s voice is being heard.  And what they are saying is, labor wants a bigger piece of the pie.

This idea offers solid explanations for several current situations.  Labor, aka Main Street, wants government to work for them, to protect their jobs and incomes.  They care far less about a company’s share price and far more about the company investing in the business and expanding.  Capital, aka Wall Street, wants the government to work for them, to keep financing costs down to increase capital productivity and drive share prices higher, whether through share repurchase or reduced expenses (aka job cuts).  

Right now, labor is in the ascendancy.  (It is ironic that labor’s ascent has been deemed right-wing, given the long history of its left-wing tendencies, but there you go).  As long as this remains the case, I think we need to consider how it will impact markets going forward.  Russell’s short-hand trade idea has been long GLD vs. short TLT (the long-bond ETF) and it has worked well for quite a while.  Can bond yields continue the rise that began in 2022?  Certainly.  Can gold continue its rally?  Of course.  Look at the chart below of gold and 10-year Treasury yields over the past 5 years.  There is nothing about the chart that says we are topping in either case.  Higher yields and higher gold prices seem contradictory, but they have been the reality for three years already.  I have explained numerous times that the world we knew is gone.  This may well be part of the new reality.  What about equities?  I have to believe multiples will be compressed which will not help them at all. And the dollar?  While higher rates seem like they should support the greenback, the case for capital flows leaving the US equity market is very real.  We could easily see the dollar decline further over time.

Source: tradingeconomics.com

Ok, let’s look at markets overnight.  Green continues to be the theme today after solid rallies yesterday in the equity markets.  I know this is not what I discussed above, but that is the long-term perspective, not the day-to-day.  Right now, the tariff pauses have traders and investors feeling a little more secure, as well as word that several nations are close to new trade deals with the US with significantly lower tariffs.  Yesterday’s modest US rally was followed by similar modest gains in Asia with the Nikkei (+0.8%) leading the way while both Hong Kong (+0.2%) and China (+0.1%) managed to gain, but only just.  Meanwhile, in Europe, the gains are somewhat better as the DAX (+1.0%) and IBEX (+1.2%) are leading the way with the FTSE 100 (+0.8%) and CAC (+0.25%) lagging a bit.  We did see some solid employment data from the UK with employment rising 206K over the past 3 months while earnings and the Unemployment Rate remained unchanged.  However, Germany is a bit more confusing given the ZEW Economic Sentiment Index there fell from 51.6 to -14.0, as the trade concerns really start to bite.  As to US futures, at this hour (7:20) they are slightly higher, about 0.15%.

In the bond markets, Treasury yields have edged higher by 1bp but remain below the recent peak at 4.50%. In Europe, we are seeing yields climb everywhere except the UK, where gilt yields are unchanged.  But Italian BTPs (+5bps), French OATs (+3bps) and German bunds (+3bps) are all under a bit of pressure this morning.  Perhaps this is a day where risk managers feel more comfortable about things, so bonds feel less compelling.

Oil (-0.4%) had a pretty big trading range yesterday but closed close to unchanged.  This morning it is slipping a bit as we continue to see demand forecasts reduced by various analysts with the IEA the latest culprit. Personally, I see prices declining from here.  As to the metals markets, gold (+0.25%) which slipped yesterday morning and rebounded all day and through the night continues to have significant support.  Silver is little changed this morning and copper (-0.7%) is backing off some of its recent gains, although is still higher by ~14% in the past week.

Finally, the dollar, which has been under general pressure lately, is stabilizing with the DXY clinging just below 100.00.  This morning, we see the euro softer but the pound and Antipodean currencies rallying, albeit not that much.  But generally, after several days of very large moves, with 2% gains for the euro and Aussie last week, most movement is 0.5% or less today and the randomness implies we are seeing positions being adjusted rather than new activity.

On the data front, here is what the rest of the week brings.

TodayEmpire State Manufacturing-14.5
WednesdayRetail Sales1.3%
 -ex Autos0.3%
 IP-0.2%
 Capacity Utilization78.0%
 Bank of Canada Rate Decision2.75% (unchanged)
ThursdayECB Rate Decision2.25% (-0..25%)
 Initial Claims225K
 Continuing Claims1870K
 Philly Fed2.0

Source: tradingeconomics.com

The only release yesterday was the NY Fed inflation expectations data which, it should be no surprise, rose to 3.6%.  I suppose that the virtual nonstop reporting that the tariff regime is going to raise inflation is having an impact.  From the Fed, yesterday we heard that patience remains a virtue and Governor Waller is in the transitory impact of tariffs on inflation camp.  There are two more Fed speakers today, Barkin and Cook, but nothing has changed my view that they are not that relevant now.

Big picture, my take is this is a reprieve before the next bout of risk selling.  The selling can last into the summer as I think it will take until then before we get a better understanding of the outcome of the trade situation.  Maybe that will be the bottom, or if trade relations worsen, perhaps another leg lower is to come.  As to the dollar, while I don’t see a collapse, I do think lower is the way.

Good luck

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End of Days

Posted on by

The one thing about which we’re sure
Is risk assets lost their allure
It’s not clear quite yet
How big a reset
Is coming, and what we’ll endure


Now, I don’t think its end of days
And this could be quite a short phase
But don’t be surprised
If answers devised
Result in a lack of real praise

Chaos continues to reign in the markets as volatility across all asset classes has risen substantially.  Perhaps the best known indicator, the VIX, is back at levels seen last during the Covid pandemic.  Remember, the VIX is a compilation of the implied volatility of short-term equity options, 1mo – 3mo.  While markets can technically be volatile moving in either direction, the VIX has earned the sobriquet of ‘fear index’ as equity volatility most typically rises when stock markets fall.  As you can see from the below chart, the movement has not only been large, but very quick as well.

Source: finance.yahoo.com

The key thing to remember is that while volatility levels can rise very quickly, as the chart demonstrates, their retracement can take quite a long time to play out.  Part of that is that even when things start to calm down, many investors and traders are worried about getting burnt again, so prefer holding options to underlying cash positions.  At least until the time decay becomes too great.  My point is that look for trepidation amidst the trading community and markets in general for a while yet, even if by Friday, the tariff situation is made perfectly clear.  Of course, with that as background, we cannot be surprised that the Fear & Greed Index has made new lows.

Source: cnn.com

However, arguably of more concern is the price action in US Treasuries, which despite the havoc in the market, are not playing their historical safe haven role.  Instead, Treasury bond yields are rising, actually trading as high as 4.50% around midnight last night although they have since retraced a bit.  The bond market has a generic volatility index as well, the MOVE index, and it, too, is trading at very high levels, the highest since the GFC.

Source: finance.yahoo.com

In many ways, this is of much greater concern to markets, as well as both the Treasury and the Fed.  The 10-year US Treasury is the benchmark long-term rate for the entire world.  A rise in the MOVE index may indicate that there is something wrong with the bond market and its inner workings, or it may be an indication that inflation expectations are rising quickly.  Whatever the reason, you can be certain the Fed is watching this far more carefully than the VIX.

I have heard two explanations for the bond market’s recent performance as follows:  first, there are those who are saying that China is selling its Treasury bonds and using the dollar proceeds to buy gold.  Now, while their holdings have been slowly shrinking, they still have just under $800 billion, so that is a lot of paper and would clearly have an impact.  The thing about this thesis is we will be able to determine its reality when China next reports their reserve numbers next month.  

The other explanation rings truer to me and that is the bond basis trade may be unwinding.  Briefly, the bond basis trade is when investors, typically hedge funds, arbitrage the difference in price between cash Treasury bonds and Treasury bond futures on the exchange.  The current positioning is these funds are long cash and short futures, and since it is a basis trade, they typically lever it up significantly, with leverage ratios of up to 100x I understand.  The total size of this trade is estimated at > $1 trillion.  Now, if this arbitrage disappears, or these funds are forced to liquidate this strategy quickly, it could be a real problem for the Treasury market.  

Ever since the GFC and the Dodd-Frank legislative response, banks no longer carry large bond risk positions and are not able to absorb large transactions seamlessly.  During Covid, you may remember that Treasury yields were all over the map, crashing and then exploding higher one day to the next, and that was caused by this basis trade unwind.  Back then, the Fed purchased nearly $1.7 trillion in QE to stabilize the market, and by all accounts, the basis trade was half the size then that it is now.

Remember, too, arguably the most important part of the Fed’s mandate is to maintain Treasury bond market stability.  Without this, the US will not be able to fund its debt and deficits.  So, whatever your view of how Chairman Powell may respond to the tariff story, which seems to be patience for now, if the bond market starts to break, you can be sure the Fed will step in.  QT will reverse to QE in a heartbeat as they offset the impact of this position unwinding.  If that is the case, I anticipate we will see further weakness in equities and the dollar, while gold will truly shine both literally and figuratively.  I’m not saying this is what is going to happen, just that this explanation makes more sense to me.  

Ok, now that tariffs have officially kicked in as of midnight last night, let’s see how markets are responding this morning.  Most equity markets continue to struggle after yesterday’s disappointing US session, where higher opens eroded all day with the major indices all closing on their session lows.  This bled into Asia where Japan (-3.9%) gave up most of yesterday’s gains although both China (+1.0%) and Hong Kong (+0.7%) held up well amid government support.  As to the rest of the region, Taiwan (-5.8%) was worst off, but other than Thailand and the Philippines, both of which managed gains, every other index was lower, often sharply.  In Europe, the realization of the tariffs is hurting with declines of -3.0% to -4.0% across the board.  As to the US futures market, at this hour (7:25), all three major indices are lower by at least -1.0%.

Bond yields are all over the place this morning with Treasuries (+8bps) continuing their recent climb amid the fears discussed above.  However, in Europe, things are such that German yields (-1bp) are doing fine while UK Gilts (+9bps) are suffering along with Treasuries.  The rest of the continent, save the Netherlands, has also seen yields rise, but much less, between 2bps and 5bps.  Overnight, JGB yields were unchanged as players are uncertain as to the next steps by the BOJ there.

In the commodity market, oil (-5.6%) is once again under major pressure.  This feels like a confluence of both technical factors (the price has broken below long-term support at $60/bbl and is now testing for lows) and fundamental factors, with OPEC raising output and the mooted recession likely to reduce demand.  Interestingly, lower oil prices are a tremendous geopolitical weapon for the US as both Russia and Iran are entirely reliant on them for financing their activities.  As to the metals complex, gold as regained its luster (sorry 😁) rallying 2.8% and well above the $3000/oz level.  This has taken silver (+3.1%) and copper (+3.5%) along for the ride.  It seems to me the copper story is not in sync with the oil story as a recession would likely drive copper prices lower, but that is this morning’s movement.

Finally, the dollar is softer again this morning with the euro (+0.8%) trading through 1.10 and the yen (+1.0%) back below 145.00.  It’s interesting because there was a story last night about how the new Mr Yen, Atsushi Mimura, was speaking to the BOJ amid concerns that the yen has been too volatile.  However, to my eye the movement has been relatively sedate, strengthening gradually and still, as can be seen in the chart below, substantially weaker than for the many years prior to the Fed beginning to tighten policy in 2022.

Source: finance.yahoo.com

The other noteworthy move is CNY (+0.5%) which after slipping to levels not seen since 2007, has retraced somewhat.  If Treasury bonds are not seen as haven assets for now, the dollar has further to fall.

On the data front, the FOMC Minutes at 2:00pm are released, but given all that has happened since then, it is hard to get excited that we will learn very much new.  We also see EIA oil inventories with a modest build expected, but this market seems likely to have adjusted those numbers outside any forecasting error bars.

The tariff story will continue to drive markets for now as investors try to determine the best way to protect themselves until things settle down.  And things will settle down, but when that will happen is the $64 trillion question.  FWIW, which is probably not much, my sense is that we have a few more weeks of significant chop, as we await clarity on the tariff policy (meaning its goals).  I still believe there will be a number of deals that will reduce the initial numbers, but the ultimate goal is to isolate China.  It is going to be messy for a while yet.  As to the dollar through all this, my sense is lower, but not dramatically so.

Good luck

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