Tag Archives: #treasuries

Just a Ruse

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Said Scottie, since Congress keeps spending
And frankly, it seems never-ending
We’re going to buy
More bonds as we try
To stop yields from keeping ascending

The market response to this news
Was instant, as it did infuse
A bid to all risk
With movement quite brisk
Though skeptics claim it’s just a ruse

Boy, I leave you alone for one day and look what happens!

At 8:33 yesterday morning, the following announcement hit the US Treasury website [emphasis added]:

Treasury Announces Increased Sizes of Nominal Long-End Liquidity Support Buybacks Beginning September 9

WASHINGTON, D.C. —The U.S. Department of the Treasury is increasing, by at least double, the size of liquidity support buyback operations for longer-dated nominal coupon securities (the 10-year to 20-year sector and the 20-year to 30-year sector).  The current maximum size of $2 billion per operation will be at least $4 billion per operation. 

This change is effective September 9, 2026 and will be in effect for the remainder of this refunding quarter (through November 4, 2026).  Treasury will provide more information about future buyback sizes at the next Quarterly Refunding, scheduled for November 4, 2026. 

This increase in buyback operation sizes reflects Treasury’s desire to provide greater liquidity support in longer-dated nominal sectors where there is consistent strong sponsorship from market participants, as evidenced by the significant volume of high-quality offers Treasury routinely receives in longer-dated buyback operations.

An updated tentative Treasury buyback schedule will be released at a later date.

First, here is a picture of the market reaction in the DXY and gold, the two things that responded most aggressively.  (I inverted the scale for the DXY, so it fell on the news.)

Source: tradingeconomics.com

And here is the bond market response with that gap occurring between 8:30 and 8:35.

Source: tradingeconomics.com

Obviously, this was a big deal, right?  Well, that’s a good question and one worth discussing.  As a baseline, the size of the current program that they are doubling is a maximum of $2 billion per operation, which means that the new limit is at least $4 billion per operation.  Now, while an extra $2 billion of demand is nothing to sneeze at, we must consider how much of that debt is currently outstanding.  According to Claude, which took the data from the Treasury website, there is about $3.7 trillion of debt that currently has between 10 and 30 years left to maturity, held by private investors.  When adding the intragovernmental holdings and the Fed, that number appears to be about $5.4 trillion.  

There are seven more of these operations planned before the November deadline, so they will be purchasing an additional $14 billion of notional value, probably paying about $8 billion in cash given it all has much lower coupons so trades at a steep discount to par (and funding it by issuing T-bills).  And if we do the math, that means they will have absorbed (assuming the smaller outstanding of privately held debt) 0.38% of the notional.  

The caveat here is the ‘at least’.  Arguably they could buy any amount and stay within the confines of the announcement and that would certainly have a much larger impact.  But everything I have read is focused on the extra $2 billion.

With that in mind, and while I’m just an FX poet, my long experience in markets tells me that removing 38 basis points worth of some security or asset from a market is unlikely to have a major long-term impact on the supply/demand balance given there is real elasticity here.

So, while yesterday’s moves were certainly impressive (gold +4.3%! as an example) I might contend that the movement was based on the narrative rather than the actual market impact.  But the one thing we have learned of late is that the narrative matters.

Many in the market have immediately claimed that this is an act of desperation as Secretary Bessent seeks to drive longer end yields lower.  Others have claimed that this is the beginning of Yield Curve Control (YCC), although the fact they are issuing more T-bills to buy the bonds makes it a lot more like Operation Twist, when the Fed did the same thing, sold the front of the curve to buy the back, thus maintaining the same size balance sheet but removing duration from the market.  If this were YCC, they would need to print more money to buy those bonds, and the Treasury cannot do that, only the Fed can and they are not part of the process.

Here’s what I know, Scott Bessent is a very smart guy, and somebody who understands markets better than any Treasury Secretary since Bob Rubin and maybe better, certainly better than you or I.  I also know he has been dealt a very bad hand; 2,3,5,7,8, off-suit in poker terms, so doesn’t have many good options.  And I know that he has zero control over spending amounts which falls to Congress and the President, with him merely implementing the spending, not deciding how much to spend.  I don’t know if this will be effective beyond yesterday’s market movement, but if he is able to get the narrative moving in the right direction, (i.e. there is a reduction in duration available to the market so prices there should rise and yields concomitantly fall), it may offer some more breathing room.  The fact that he is using the tools available to manage the government’s balance sheet is a huge positive.  I can only say, good luck Scott.

While there are probably other stories of some import, this was the one that got the most engagement, and I think the one with the potential longest-term impacts on things.  So, let’s see how other markets responded.  It was interesting to me that the equity markets did not wholly embrace this action, although there was an initial rally, much of it faded by the end of the session with very modest gains at the end of the day.  Asian markets, however, fared very well with Tokyo (+1.4%), China (+0.1%), HK (+0.8%) and Korea (+5.9%!) all rallying and taking almost the entire region higher.  I think it is worth showing a chart of Korea’s KOSPI to demonstrate the increase in volatility we have seen on a regular basis there since the Iran war began.  Just look at the expansion of the daily ranges, especially since May, compared to the size of those bars for the prior six months.  This is another indication that the way things were is no longer the way they are.

Source: finance.yahoo.com

In Europe, though, equity price action is desultory this morning, with modest declines of about -0.4% or so across all major markets with Spain (-0.1%) the outlier.  As to US futures, at this hour (7:15), they are edging lower led by the NASDAQ (-0.5).

In the bond market this morning, yesterday’s euphoria is being tempered with Treasury yields backing up 3bps.  European sovereigns, though, are little changed to +1bp, although they didn’t respond to the Treasury market in any real sense yesterday.  That makes sense since Bessent’s announcement was highly US specific.  As to JGB yields, they did slip -4bps overnight, and there are many who draw a direct link to Treasuries and USDJPY, with official efforts by the US to cap both of those things.

Speaking of the yen (-0.3%), it was one of the largest beneficiaries of the announcement, rallying nearly 1% as you can see in the chart below.  However, this morning it is slipping a bit, and frankly, the post-intervention pattern has not been altered by yesterday’s move.

Source: tradingeconomics.com

In fact, most currencies rallied yesterday on the news but this morning, the picture is more mixed as we see both gainers (GBP +0.2%, EUR +0.15%, NOK +0.15%) and laggards (INR -0.25%, SEK -0.3%, ZAR -0.35%).  In essence, while yesterday’s moves were large and broadly dollar lower, this morning there is more nuance.  As it happens, the DXY (-0.1%) is edging lower today, but remains directly in the middle of that long-erm 96.50 / 100.50 range at 98.71.

Source: tradingeconomics.com

Finally, commodity prices show oil (+3.1%) continuing its recent rebound and back to its highest level in about a month.  But if I look at the chart below, it remains in the middle of its much wider range as well, if anything somewhat closer to the bottom than the top.  At this point, it is impossible to know what is happening in the Gulf war and frankly, I think market participants who don’t trade oil directly, have moved on to other drivers.  

Source: tradingeconomics.com

As to the metals markets, after yesterday’s remarkable rallies, it ought not be that surprising that they are consolidating this morning (Au -0.7%, Ag -0.3%. Cu -1.1%).  There are some analysts who believe that copper is getting set to roll over and decline in price as the narrative about shortages of supply for ever increasing data center and power production demand grow long in the tooth and may already be priced in.

On the data front, yesterday’s Minutes showed that there were non-voters who also would have been inclined to raise interest rates back in July, but we know that we have seen softer data since that meeting, so it is unclear if that is still the case.  As well, EIA oil inventories rose again, >4 million barrels, so tank bottoms are still covered!  This morning we get the weekly Initial (exp 210K) and Continuing (1790K) Claims as well as Philly Fed (25.0) and Leading Indicators (+0.1%).  There are still no Fed speakers, and I continue to believe that Chairman Warsh’s speech next week is the most important thing on the horizon.

Until then, I imagine yesterday’s surprise announcement is the biggest news we will get for a while and that we are likely to see markets return to their somnolence.  But there is a new narrative forming, the US is going to ignore inflation and push rates lower, which if it is followed implies higher commodity and equity prices and a falling dollar.

Good luck

Adf

Doomsters to Press

Posted on by 
The Payrolls report was a mess
But job losses added no stress
And so, once again
We’re back to the yen
As reason for doomsters to press

The claims being made are dramatic
Describing T-bonds as asthmatic
Explaining that Scott
Has now lost the plot
While calling his viewpoint erratic

So, what’s really happening here?
Is it true the end point is near?
I’m happy to say
Those fears I’d allay
At least through the end of next year

Once upon a time, a very smart economist, Larry Kantor, explained to me that the best signal for the economy to follow over time was the Unemployment Rate.  When it was falling, it was a strong indication that economic activity was increasing and vice versa.  But I think that is a world which no longer exists.  I make that point because Friday’s NFP report showed that the Unemployment Rate fell to 4.1% despite the fact the payrolls shrank.  Below is a chart of the Unemployment Rate since 1947 along with the average (5.7%) during that period.  The data comes from FRED although I calculated the average

Arguably, the first thing you notice is that the current Unemployment Rate is quite low relative to history, in fact it is in the bottom quintile.  But Mr Kantor’s observation was based on the then prevailing, and historical thesis of steady population growth, a thesis that has been called into question lately.  Between the aging of the population and the significant changes in immigration activity (i.e. the 2 million or so deportations recently), it is not clear that a declining Unemployment Rate is indicative of strong economic activity.  It could simply be a signal that the population is falling more quickly than job growth.

But looking at the report as a whole, it was quite confusing.  While Payrolls decline by -23K, Private Payrolls rose 30K and Manufacturing Payrolls rose 5k.  A shrinkage in government jobs seems quite positive to me.  However, Earnings data was a bit soft falling to 3.2% Y/Y, lower than the inflation rate.  Net, it is hard to draw many conclusions from the report although we did see the Fed fund futures market reduce the probability of a September hike to 56% from 66% prior.  Certainly, on the surface it hardly strikes that this is encouraging a rate hike.  And the stock market was non-plussed, rallying across the board.

Which takes us to the other story that continues to garner huge amounts of attention, the yen and the rationale behind the US joining Japan to intervene as well as what that will mean going forward.

I will try to boil this down.  The angst is attached to the carry trade, which, neatly defined, is borrowing JPY and paying a very low interest rate, converting the yen into another currency, typically USD, although AUD, MXN and BRL are also popular, and then earning the higher interest rate in those currencies.  It can be a highly profitable trade when currency volatility is low as the trader simply earns the difference between the interest rates each day.  The risk is there is a sudden move in the FX rate which can wipe out weeks or months of carry.  Hence the concern over intervention when we see the FX rate move 5% in a day like the end of July.

Estimates of its size run from $500 billion to $1.5 trillion, although nobody really knows.  I would err on the high side.  But there is another piece that is rarely discussed but I think must be considered in this conversation, and that is the outward investment flows from Japanese investors around the world, again largely to the US, but elsewhere as well.  I asked Grok to create a chart of net investment outflows from Japan from 2000 to present and got this:

Other than 2022, when the Fed started hiking rates aggressively and bond prices fell sharply, it has been pretty consistent.  The net amount of outflow over this time period is approximately ¥347.5 Trillion (again according to Grok) which at the average FX rate over the period of 112.40 works out to about $3.1 Trillion, arguably much more than the ‘pure’ carry trade.  But I don’t believe you can ignore that as if the Japanese are going to bring money home, it will be there as well.

Of course, there is no indication that is what they are doing at this point, despite all the hypotheticals about that being the major risk.  The Fiscal situation in both the US and Japan is awful, with both nations running huge budget deficits and showing no signs of changing that.  Inflation has been rising in both nations and a key prescription by many is that both central banks should be raising interest rates.  Of course, if the Fed raises and the BOJ waits, that widens the differential and will theoretically put more pressure on the yen.

The key concern and the favored story as to why the US helped Japan is that they didn’t want the BOJ to have to sell Treasuries to fund their USD sales.  Much has been made of the fact that the US sold EUR, not USD, but that is because the Treasury doesn’t keep USD in the Exchange Stabilization Fund, just EUR and JPY and a bit of some others like GBP, so they sold what they had.

The big fear is that the US cannot afford for Treasury yields to go higher (although it seems these same folks are clamoring for the Fed to hike rates) and so will do all they can to prevent that.  Now, the funny thing is that if you are Japanese and you own USD assets, you are thrilled with the weak yen as it enhances your return.  While Takaichi-san doesn’t like the weak yen as it exacerbates inflation, I don’t think Japan’s asset holders are clamoring for a strong yen. Remember this, too, that the long-term average yield on US 10-year Treasuries is 5.81%, more than 100bps above where we are today.  It is fair to say that recent lower yields are the exception, not the rule.

To my eye, the harder needle to thread in this process is for Japan, which really doesn’t want to see its massive foreign investment decline in value, although they are concerned about inflation.  For the US, while the fiscal situation is a major problem, it remains a problem for the future.  I’m pretty confident everybody in the world will still accept dollars for payment if they are offered.  The dollar is not going to collapse, nor is the bond market.  While pressure continues to build over time, it is going to take a LONG time.  Mark my words.  The end is not nigh!

In the meantime, JPY (-0.7%) looks like it is repeating the pattern after the last intervention attempts as per the below chart.  As I have maintained, unless there are policy changes, a strong yen is not coming soon.

Source: tradingeconomics.com

Speaking of the FX market writ large, this morning has seen very little net movement across almost all counterparts with KRW (-0.7%) the only other currency moving more than 0.1% in either direction.  We have discussed the won several times recently and while the alleged proximate cause for this decline is increased uncertainty over the Strait of Hormuz, given the huge gains seen in the past 6 weeks, this is nothing more than a blip in a strong trend.

In fact, lack of movement aptly describes the bond market as well with yields on Treasuries and across all European sovereigns within 1bp of Friday’s closing levels.  Apparently, fears of the apocalypse have been put on hold for the moment.

In the equity market, Friday’s US rally has seen a general follow-on by both Asia and Europe.  Overnight saw modest gains in almost every Asian market (Tokyo +2.1%, China +0.2%, HK +1.1%, Korea +0.7%, Taiwan +1.6%, etc.) although Australia (-0.3%) managed to buck the trend.  Given the resource focus of the Australian economy, and the recent gains in metals prices, that is a bit of a surprise.  As to Europe, Germany (+0.4%) is the leader of the pack with both France and Spain basically unchanged while the UK (-0.3%) lags slightly, albeit lacking any new news.  US futures are essentially unchanged at this hour (6:45).

Finally, oil prices (+1.4%) are firmer this morning as the ongoing saga over the Strait remains cluttered with confusion as to if a deal is coming close, or not and what role, if any, the US is going to play.  Personally, I’m ready for the US to exit the area, but they don’t ask me.  As to the metals markets, gold (-0.1%) is consolidating after a very strong performance last week, rising 7%, and silver (+0.8%) is continuing last week’s gains.  But to me, copper (+0.5%) is the metal with the most upside as the supply/demand characteristics of the market, (not enough is mined to satisfy annual needs and the timeline to bring a new mine up to speed exceeds a decade), imply higher prices still despite the fact we are already at record levels.

And that’s all.  We have no data today although CPI comes Wednesday.  I will look at data tomorrow as I have already gone too long this morning.

Good luck

Adf

Pundits and Bores

Posted on by 
The fallout from Warsh’s decision
To leave rates without a revision
Has opened the doors
For pundits and bores
With hawks and doves set for collision

For some, Warsh has failed from the start
As they felt a rate hike was smart
But others explain
That under his reign
It’s markets that play the main part

For a no action outcome by the Fed last week, it certainly is interesting how much digital ink has been spilled discussing the outcome of that meeting and, depending on which side of the argument you fall, whether it was the right move or an error.  You know I have been of the belief that there will be zero rate hikes this year and nothing has changed that opinion yet.

There is a great deal of conversation regarding the Fed’s credibility and how despite Warsh’s tough talk about achieving their 2% inflation goal at his first meeting, by doing nothing last week, he has trashed that credibility.  My first thought here is, given the Fed has failed in its key objective for more than 5 straight years on its own terms, it is difficult for me to accept they had a lot of credibility left to trash.  But my second thought is to listen to the Chairman’s words about allowing the market to do its job, and not simply watch the Fed, and I realize there are an awful lot of analysts and pundits who don’t know how to do that and therefore are extremely uncomfortable now.  As I wrote last week, these folks get paid a lot of money by Wall Street and now they have to earn it.  So perhaps that explains the ongoing diatribes.

Much has been made of the fact that between the June and July FOMC meetings, US Treasury yields rose substantially as you can see from the below chart.

Source” tradingeconomics.com

At the close on Friday, they had risen 34bps in the 30-year and 28bps in the 10-year), although this morning, with oil prices (-5.6%) falling on the back of a renewed diplomatic initiative in Iran, both of those bonds have seen yields back off by 5bps. 

Now, one of the things that Warsh specifically explained in the press conference was that the market had raised rates already, effectively doing the Fed’s job for them.  And here is the point of departure, I believe, regarding the punditry viewpoint and the Warsh viewpoint.  Warsh has been explicit in saying he wants the Fed’s footprint in the markets to shrink.  He wants market participants to, “play the ball, not the referee”.  However, the pundits claim that the only reason rates rose was in anticipation of the Fed hiking rates.  

So, let’s try a little thought experiment.  Assume there was no Fed, instead that money supply was mechanically increased by 2% per year and that all interest rates were determined by the market.  Do you believe that in this scenario, a government running consistent extremely large deficits would not drive interest rates higher than they otherwise would be, without a central bank to officially do so?  I know I do.  Is that any different than the market pushing yields higher because they are concerned with excess supply of Treasuries and other inflation concerns?  

The Fed has had a major, and in Warsh’s (and my) view, too large impact on markets for a long time, since Black Monday in 1987.  Change is hard and the punditry does not like the fact that they are going to have to actually think and pay attention to many variables in order to have a viable view on things, so they are all crying and claiming Warsh is making a huge mistake.  While not surprising, I think they are completely wrong.  

It is also important to understand that the current yields in the bond market are anything but ordinary. Below is a chart I created with FRED data and included the long-term average 10-year yield since 1962, which happens to be 5.81%, more than 100bps above current levels.  For a very long time, a good rule of thumb for the 10-year yield was it should be approximate the nominal GDP growth rate, but we have gone through such a long period of financial repression, that idea faded away.  Perhaps that is coming back into vogue, so at the long-term average, we could see 3.8% GDP growth and 2.0% inflation.  And even today, it could represent 2.7% GDP growth and 2.0% inflation.  I don’t think anybody would be unhappy with that outcome.

My understanding is the task forces will not be reporting until early next year.  At the same time, I am convinced that Mr Warsh is very serious about making significant changes at the Fed going forward, and I applaud that.  But it is going to require him to convince 18 other people who have been inculcated in a process that has proven to be a failure but offers comfort to those people because they know how it works.  Change is very hard, and this will be harder than most.  One last thing, the biggest change is going to be the balance sheet.  The Fed continues to buy T-bills and expand the balance sheet as they continue to seek to maintain “ample” reserves, so banks have liquidity.  I would not be surprised if when we hear from Chairman Warsh at the Jackson Hole meeting at the end of the month, he indicates the Fed will stop buying bills at the next meeting moving further down the path of change.

Surprising comments
Bessent admitted the Fed
Joined the Japanese

The following statement released by Japan’s MOF is quite a surprise, at least the fact that they admitted to the action, something that has rarely been the case in the past.  

Some have made the point that given Japan is the largest holder of Treasury securities in the world (other than the Fed) and that they would need to sell their Treasuries to fund intervention, this was the driving force.  Certainly, the US is not keen to have holders sell their bonds at this point.  As you can see in the chart below, this intervention has had a larger impact than the previous bouts which were solo Japanese efforts.

Source: tradingeconomics.com

At the dollar’s low, the yen appreciated about 5% in the past two sessions, certainly a very large move.  One of the other things that was interesting was that ostensibly, the Treasury sold EURJPY, not USDJPY.  Perhaps they had extra euros lying around they no longer wanted.  According to BOJ data, it appears the Japanese spent something like $33 billion on the intervention, but I have no indication as to the US effort.

Joint intervention is pretty rare, with the last time being in the wake of the earthquake/tsunami at Fukushima in 2011 when the yen strengthened dramatically.  But it also has a better track record than solo intervention, although absent significant fiscal changes, on both sides of this equation, I suspect that within a few months, the yen will weaken again.

Ok, I feel like that’s enough for one morning.  The oil story, as I mentioned, is that the President has called off the mooted weekend attacks and diplomacy is back on the table.  Interestingly, the metals markets are not as excited by that with gold (+0.15%), silver (+0.6%) and copper (+0.75%) all higher, but not by very much, especially given the size of the decline in crude prices.  And product prices (gasoline -3.4%, heating oil -3.0%) are also sharply lower.

As also mentioned above, bond yields have backed off with European sovereigns sliding far more than Treasuries, between -6bps (Germany, Netherlands) and -9bps (UK, Italy, Greece).  However, JGB yields (+3bps) did not get the memo although I suppose that has more to do with the belief that the BOJ is going to be forced to hike rates as part of the joint US-Japanese currency efforts.

As to the equity markets, after Friday’s US rally, the picture in Asia was mixed, despite the oil price decline, although for Japan, a stronger yen is often a problem for Japanese equities.  The worst performers were Korea (-5.1%), Tokyo (-0.9%) and China (-1.0%) while much of the rest of the region followed the US higher (HK +0.5%, India +0.7%, Taiwan +0.6%, Australia +0.5%) with the smaller exchanges mostly higher as well.

In Europe, things are generally bright with Germany (+1.4%), France (+1.3%) and Spain (+0.75%) all nicely higher despite (because of) modestly weaker PMI data although the UK (0.0%) has not been able to overcome its PMI weakness.  Now, in fairness to the UK, its 51.9 reading, while weaker than last month and forecast, is still about the best in Europe.  As to US futures, they are all in the green, led by the DJIA (+0.8%) at this hour (7:00).

Finally, the dollar is kind of confused overall.  The big winner today is KRW (+1.0%) although that trade has been ongoing for more than a month and is approaching an 8% gain over that period.  The yen (+0.4%) continues to climb, albeit less aggressively, although the other G10 currencies are generally under pressure (GBP -0.15%, AUD -0.3%, CAD -0.2%, NOK -0.6%).

However, I must mention something that Alyosha wrote this morning in Market Vibes that is worth considering; two of the major positions in markets were short bonds and short yen.  Joint intervention by the US and Japan to sell EURJPY has likely forced a lot of covering in both of those markets and it would not be surprising to see more activity like that and further short covering.  Japan is the largest holder of French bonds as well as Treasuries and could easily sell those without a peep from the US.  

Ok, I have gone way over my daily quota this morning, although there were a couple of really big, and complex stories to discuss.  On the data front, today brings ISM Manufacturing (exp 54.0) and I will delve into the rest of the week’s data, including Friday’s payroll report tomorrow.

Good luck

Adf

Dust in the Wind

Posted on by 
A line has been drawn
Is it steel reinforced? Or
Just dust in the wind?

Shortly after 9:30 yesterday morning, the BOJ entered the FX market aggressively selling dollars as you can see in the chart below.  While the amount sold is unknown at this time, it was likely pretty large, ~$10 billion – $15 billion would be my guess.  In addition to the sales, though, apparently the Fed called around the Street “checking rates”, although my understanding is the Treasury didn’t actually sell any dollars.

Source: tradingeconomics.com

Regardless, the signal of an approved, if not joint, intervention is powerful and I expect that the market will take some time before pushing the dollar back higher again.  Now, one of the themes yesterday was that the BOJ would also raise interest rates at their meeting last night in a surprise move as a way to reinforce this action.  I believe if they had done so, it could have been quite effective and we would have seen another sharp leg lower, as well as an overall reduction in pressure on the yen.  But they did nothing with their base rate remaining at 1.0% and, as you can see from the chart, the drift has already begun for the yen to weaken once more.

As I have maintained throughout this process, absent policy changes of substance, and at this point in Japan that includes fiscal as well as monetary, pressure on the yen is very likely going to be the norm.  Of course, if the Fed really does begin to ease policy at some point, that will alter opinions and I imagine soften the dollar universally.  

The pundits are still really pissed
That Warsh, their concerns, has dismissed
Get ready to hear
That Doomsday is near
If Warsh keeps ignoring their gist

Since we seem to be in an interlude in the war in Iran and the Middle East, so oil markets remain quiet and there has been little news from the White House, the punditry has continued its focus on Fed Chair Warsh and all the things they hate that he is doing.  This is well summed up in this morning’s WSJ article titled, ”Kevin Warsh’s Honeymoon with the Bond Market Is Already Over”  interestingly, this was not written by Nick Timiraos, but rather by Sam Goldfarb, their bond market guy.  Personally, I think he is completely wrong, but the punditry is consistent in their desperate desire for Warsh to tell them what the Fed is going to do so they can report it and seem smart.

However, my read on the bond market response is quite different, especially when put in context with other markets, notably inflation markets.  The fact that the 2-year yield has backed off, and we have already seen a modest pull-back in the 10-year tells me that there is limited fear of rampant inflation.  While the pundits, and many other central bankers (see Lagarde, Christine) think that hiking rates into an energy price shock is the right move, it has historically been a key policy error.  And what we have learned from financial history is that it is NEVER different this time.  And the folks who trade inflation have breakevens (the difference between nominal Treasury yields and TIPS yields of the same maturity) trading at very ordinary levels of 2.27% in the 10-year and 2.22% in the 30-year.  I thought that Alexandru Stefan Goghiedid an excellent job of describing the situation in his Substack article this morning.

In the meantime, you know who else isn’t really worried about this?  Equity investors.  Broadly speaking, green is today’s color in that asset class, with some of the real movers not even shown in this Bloomberg Screenshot.  

For instance, the KOSPI rallied 17.9% last night after Amazon and Microsoft’s earnings got everybody reconvinced that the AI trade was not over.  This is the market that I had been highlighting as collapsing and it just did a major reversal.  Last night’s candle, on the right-hand side of the chart, is one of the largest you will ever see in a major equity market!

Source: finance.yahoo.com

So, we have made it through the major tech earnings releases and spirits are still high.  While the Fed funds futures markets are still pricing a two-thirds probability of a hike in September and the certainty of one by October, the recent cooler than expected CPI and PCE data will continue to give ammunition to remain on hold.  To me the real question is, will Chairman Warsh be able to convince the committee that reducing the balance sheet is the right thing to do (it is) as that will have a much stronger impact on inflation than raising rates into the energy price shock.

In an aside, lately I have been wondering if every Fed governor should be fired for ‘cause’.  After all, according to legal precedent, cause can mean:

  • Inefficiency – persistent inability or incompetence in performing the role’s administrative or official functions
  • Neglect of duty
  • Malfeasance in office

Now, I would not accuse them of the latter two, but let’s face it, they have completely failed in their official functions as evidence by the fact that even on their own terms of stable prices, it has been more than 5 years since they have achieved their goal.  That seems pretty inefficient or incompetent to me!

Ok, let’s run through the other markets.  Bond yields are higher by 1 tick around the world, and we have discussed them already.  JGB yields, have slipped -2bps, so maybe they are not as worried with the yen strength from yesterday.

Commodity markets are dull with oil (+1.5%) having rallied in the past hour but still hanging around the $85/bbl level with no new news on the war.  At the same time both gold (-1.2%) and silver (-2.0%) are under pressure this morning, although that doesn’t make a huge amount of sense to me given the dollar’s broad weakness.  Perhaps the fact that it is month end is driving flows there, but I am not close enough to those markets to know.

Finally, the dollar is softer, having fallen sharply yesterday although bouncing somewhat this morning.  As you can see in the DXY chart below, we are back within the 96.50/100.50 range that has prevailed for most of the past year and have traded below 100.00 several times yesterday and early this morning.

Source: tradingeconomics.com

To me, this is very interesting as FX traders seem to be taking different signals from the Fed than the short-term interest rate guys.  This does not feel like a market that is anticipating rate hikes in the US.  Now, historically, when it comes to opinion differences across markets, FX traders are the worst of the worst.  And, of course, I am an FX guy at heart, but I have a feeling they are correct here and I still see no rate hikes this year despite the Fed funds futures markets relative certainty.  So, right now, the dollar is broadly firmer by 0.3% across the board with the biggest outlier KRW (-1.35%) seeming to follow the KOSPI.

I think the really important thing to remember here is that the dollar has just not done very much, at least against the G10 currencies, for more than a year.  Certainly, LATAM currencies have performed well this year, but it remains difficult for me to look at the rest of the G10, a group with weak economic activity, and get excited about owning any of them.

On the data front, the PCE data was as expected to softer, but the real key yesterday was the GDP data which showed nominal GDP rose 7.9%, although the inflation adjusted number was just 1.5%.  But this is the very essence of running it hot, high nominal growth, which consisted of significant consumption and investment, while allowing inflation to run as well.  From a debt management perspective for the US, the debt/GDP ratio fell accordingly by about 1%.  While this trend remains higher, I expect we will see more of this type of outcome going forward.

As to today’s releases, Chicago PMI (ep 56.0) and Michigan Sentiment (54.0) are what we see, neither of which seems likely to matter to markets.  The equity bulls are back and that is going to be today’s story.  If those rallies fail, it will portend larger problems I believe, but my take is that is not going to happen.  I guess we shall see.

Good luck and good weekend

Adf

Starting To Bite

Posted on by 
The meeting between Trump and Xi
Had little but hyperbole
So, markets now turn
To their key concern
Inflation that’s grown one, two, three

While oil has garnered attention
Tis yields and their latest ascension
That’s starting to bite
And causing a flight
Of buyers, and lots of press mention

And one more thing that you should know
Is China continues to slow
Through all of Xi’s bluster
He simply can’t muster
His people to get-up-and-go

As we begin a new week, a quick review of the last one shows that the much-touted Trump-Xi summit didn’t seem to address any of the current problems, at least as defined by what financial markets deem problems.  These are the lack of transit ability through the Strait of Hormuz, with the resultant limit on oil supplies and the resulting rise in prices and inflation as energy prices feed into the price of everything else.  I guess it was always a great leap to believe that this summit was going to end the war, and depending on which side’s comments you read, China has either agreed, or not, to try to push Iran to reopening the Strait.  Certainly, they would like that to be the case, but thus far, as I type Monday morning, there has been no further movement.  In fact, last night, the President sent this message out.

I guess we cannot rule out a further escalation of military action in Iran at this point, and I imagine the oil market will not be pleased.

Speaking of China, though, while many want to continue telling the story that they are weathering the Iran conflict with limited impact because they had stockpiled so much stuff ahead of time, below are their latest economic data statistics, a grouping that does not shout, at least to me, of a nation hitting on all cylinders.

Source: tradingecomomics.com

I am confident that we will once again hear about all the stimulus that President Xi will soon add to the Chinese domestic economy as they seek to increase the proportion of domestic activity compared to their export focus.  But I would take the under there.  First, if you thought that politicians in the US didn’t care about their constituents, compared to Xi, they wait on their constituents hand and foot.  But history has shown that China’s model is to support chosen industries, as I showed on Friday, and subsidize them so they can learn to dominate all competitors.  

Arguably, the one time they were willing to subsidize the domestic economy was with the property market, although that simply led to the construction of the so-called “ghost” cities, where people invested in the property bubble, as they had few other outlets to save money, and enormous amounts of resources were consumed to build cities that never had any occupants.  Alas, for all those investors, those cities still don’t have occupants, and with a shrinking population, never will.  The property market has been shrinking in value for 4 years now and shows no signs of slowing as per the below chart of the House Price Index from above.  

Source: tradingeconomics.com

While things are certainly not perfect here, China’s got problems as well, just remember that.

But arguably the real story right now is bond yields as Treasury yields, and those almost everywhere else in the world, continue to rise.  As you can see from the Bloomberg screenshot below, while the overnight movement has not been excessive by any stretch, yields have now risen pretty aggressively over the past month, and year, and are trading at their highest levels since the 2022 inflation peaks.

Now, if we look at the below chart from tradingeconomics.com, it shows 10-year yields over the past 5 years.  You can see that US yields have not yet reached their October 2023 highs (driven then by the combination of strong economic growth and ongoing QT as inflation remained high from its Covid induced rise), but both Germany (green line) and Japan (brown line) are at their highest levels in quite a long time.  We have discussed Japan numerous times over the past months, but not spent much time on Germany.  However, the German story is one of stagflation.  I have shown how poorly German economic output has grown over the past 5 years, as it has essentially stagnated over the entire timeframe.  Now, add the self-inflicted energy policy insanity, that had already severely impacted Germany before the Iran conflict, and then the Iran conflict and $100/bbl oil prices, and the Germans have even more problems.  

Here in the States, the recent inflation data has been consistently higher, and higher than expected and the great white hope of AI-induced deflation seems to always be a little further away than hoped/expected.  It remains difficult for me to see a scenario where prices fall dramatically in the US anytime soon as there is too much economic stimulus to allow for a recession, let alone a depression, which is what I think would be needed to get prices to fall.  In this world, yields will continue to creep higher, at least until such time as Iran is no longer an issue.  One other thing to remember is that there is a massive short position in bond futures, upwards of $1 trillion across all maturities, although that is entirely driven by hedge funds in the basis trade, where they are long cash bonds and short futures as an interest rate hedge.  But that only works as long as the math works (funding costs are less than the carry they earn).  The point is, if short end rates start to rise such that funding is too expensive, we can see a massive unwind of that position, which would mean huge sales of cash bonds, and that will really drive yields higher.  However, if that were to start to play out, even Mr Warsh, he of the shrinking balance sheet idea, will be out there buying bonds to prevent a collapse.

Ok, I’ve gone on too long, so a really quick tour of the markets overnight follows.  Friday’s US equity selloff was followed by weakness across the board in Asia (Japan -1.0%, HK -1.1%, China -0.5%, Taiwan -0.7%, Australia -1.5%) although somehow Korea (+0.3%) managed to hold in there ok.  In Europe, while the UK and Germany are essentially unchanged this morning, both France (-1.0%) and Spain (-0.7%) are under pressure, following the trend.  US futures, at this hour (7:30) are also lower across the board, on the order of -0.6% or so.

Of course, underpinning all of this is oil (+1.2%) which continues to climb slowly higher as fears over an escalation in Iran have removed hope for a resolution.  Oil is higher by nearly 9% in the past week and 22% since this time last month.  In the metals markets, gold and silver, which both fell sharply on Friday into what appears to have been some major option expiration liquidation, are little changed this morning although copper (-0.8%) is still sliding from its highs amid overall market concerns about risk.

Finally, the dollar, which had a very strong week last week, is ever so slightly softer this morning, -0.1% on the DXY although there are two currencies with more substantive moves, NOK (+0.5%) on the back of the oil rally, and COP (+1.1%) which seems odd given copper’s performance today, but remember, copper is still within spitting distance of its all-time highs set last week and higher by 35% in the past year.

On the data front, it is extremely quiet this week with only a handful of meaningful numbers, although all eyes will be on NVDA’s earnings Wednesday after the close.

WednesdayFOMC Minutes 
ThursdayInitial Claims210K
 Continuing Claims1790K
 Housing Starts1.41M
 Building Permits1.40M
 Philly Fed186
 Flash Manufacturing PMI54.0
 Flash Services PMI51.0
FridayMichigan Sentiment48.2
 Leading Indicators-0.3%

Source: tradingeconomics.com

We also get 7 Fed speeches, although only four speakers in total.  And remember, too, next weekend is the holiday weekend, so as summer approaches, trading desks will start to thin out.

My take is all eyes will be on the bond market for now, which will obviously be driven by oil prices, but also by the huge basis trade.  As to the dollar, I see no reason to sell it with any force, that’s for sure.

Good luck

Adf

Simply No Need

Posted on by 
Said Powell, there’s simply no need
To hike rates, we all have agreed
But likewise, no case
To cut, lest we face
An outcome where, jobs, we impede

Said Trump ‘bout the Strait of Hormuz
Be careful and do not confuse
Our aims in this war
As more than before
Which has been, Iran, to defuse

Just like every other day, this morning shows we really have no idea what to believe regarding the war anymore.  The headline in the WSJ is that President Trump may consider the job finished even if the Strait of Hormuz remains closed.  That has certainly gotten the Europeans up in arms as they are the ones relying on its reopening to source much of their oil and LNG.  But consider it from the US perspective, where we source only about 2.5% of our oil related products from nations on the wrong side of the Strait, which means virtually none of our overall import roster (source Grok). 

Now, the one thing I will say about President Trump is that strategic ambiguity is one of his strengths, as he continues to make so many seemingly contradictory statements, nobody knows what he is working to achieve.  Based on the framework that Secretary Rubio laid out again yesterday:

  1. Destruction of Iran’s Navy
  2. Destruction of Iran’s Air Force
  3. Severe diminishment of their missile launching capability
  4. Destruction of their armaments factories

It is not hard to believe the US and Israel are close to their goals.  However, none of this discusses Iran’s nuclear weapons program, which has clearly been a goal, nor the 440Kg of 60% enriched U308 that they retain.  

Again, I wouldn’t dare claim to have any idea when this will end, but the political calculus indicates it is unlikely to go on for very much longer.  However, it is not just the political calculus that implies that, but also market pricing of certain things.  For instance, one of the things that initially surprised me was that Brent crude (+0.6% today) did not initially rise more rapidly than WTI (+2.0% today).  After all, zero WTI transits the Strait and it is not a pricing benchmark for anything that happens over there, while Brent is the basis for all Middle Eastern oil.  As the Strait of Hormuz has been effectively closed since March 4th, a look at the below chart shows that Brent did not separate itself from WTI until 2 weeks later.  But last night, that spread collapsed back to its current $3/bbl, similar to the levels that preceded the onset of the war.

Source: tradingeconomics.com

One interpretation of that price action is that there is a growing belief that the Strait will reopen for transit soon.  Of course, it could simply be that neither Brent nor WTI are representative of the oil grades that are impacted, and thus the large premium no longer makes sense, but given the totality of the news, I’m inclined to lean toward the former idea.  Of course, both benchmarks are currently solidly above $100/bbl so still causing great pain.

However, on this topic, as most of us live and think in a nominal world, we consider $100/bbl as extremely expensive.  But if we take a moment to consider the real (inflation adjusted) price of oil, we can see in the chart below that energy remains pretty cheap, and well below levels seen ahead of the GFC or even in the wake of the Russian invasion of Ukraine.

Source: data FRED, calculations and chart, @fx_poet

My point is that over time, energy has become less of a cost in the economy, and even with the current situation, my take is the US, and frankly global, economy is quite resilient and will get through this.  I’m not suggesting there won’t be some pain, just that this is not going to lead to economic Armageddon.

The other interesting story from yesterday came from Chairman Powell, who in a speech at Harvard explained there was a great deal of uncertainty currently, while admitting that the tariffs were likely a one-off modest inflation pressure.  He indicated rate cuts were likely over, although hikes were possible, and then the man who printed $5 trillion to pay for every one of President Biden’s Covid and ESG bills, explained that debt is growing too fast and could be a problem going forward.   And you wonder why there are those who are skeptical of his concerns over politicization of the Fed.

Ok, let’s turn to markets.  Yesterday’s morning positivity faded all day and both the NASDAQ and S&P 500 closed lower on the session.  That mostly followed in Asia with Tokyo (-1.6%), China (-0.9%), Korea (-4.3%) and Taiwan (-2.5%) all under real pressure, although HK (+0.2%) and Australia (+0.25%) managed some gains.  Other regional exchanges were mixed as investors around the world are trying to figure out the next steps.  At this hour (7:00), US futures are pointing solidly higher, +0.8% or so.  Turnaround Tuesday?  Certainly, that is the case in Europe where despite widely expected higher Flash inflation data for March, green is today’s color with gains ranging from 0.2% (CAC) to 0.5% (FTSE 100) with others somewhere in between.

Bond investors have seemingly turned their views from inflation concerns to growth concerns, at least based on the fact that yields around the world are lower this morning than yesterday.  In fact, since Friday morning, 10-year Treasury yields have fallen -14bps, including -2bps this morning.  in Europe, yields did slide somewhat yesterday, about half that in the US, and this morning they are little changed throughout the continent.  But we did see JGB yields slip -2bps overnight as well.

On the growth side, the Atlanta Fed’s GDPNow is running at 2.0% for Q1, well below its first readings from before the Iran activity, although still in decent shape.  The next update comes tomorrow, so will be interesting to see.  And, of course, the payroll report on Friday will be critical for that reading.  It is, though, still well above the Blue Chip Consensus readings.

We’ve discussed oil, but a quick peek at precious metals shows they are regaining their luster, with gold (+0.8%) and silver (+3.6%) both nicely higher this morning.  As this price action continues, with the current price more than 10% above the spike low from March 23rd, I believe whatever was driving things during the first part of the war, may now have passed.

Finally, the dollar is little changed this morning, but sitting on its recent highs with the DXY at 100.53 as I type.  Here’s the thing about the current level.  As you can see from the long-term chart below, while during the first 4 months of 2025, the dollar did decline sharply, about 10%, the longer history shows that the current level has acted as support for a very long time.  As well, if you take the really long view, we are within spitting distance of the DXY’s average since the 1970’s.

Source: tradingeconomics.com

All I’m saying is the dollar is neither strong nor weak right now, it just is.  It is, though, worth looking at the yen (0.0%) which pushed back to just below 160 during yesterday’s session and got more jawboning from Mimura-san, the Vice Finance Minister for International Affairs (aka Mr Yen) who explained they are ready to take “decisive action” against speculative moves.  But otherwise, this morning’s session is unremarkable with only KRW (-0.6%) continuing to suffer from the energy issues there.

On the data front, we get Case Shiller Home Prices (exp +1.3%) and then Chicago PMI (55.0) and perhaps most importantly, the JOLTs Job Openings (6.92M) report at 10:00.  There are two more Fed speakers, Goolsbee and Barr, but with Powell just having confirmed no moves are coming soon, what can they possibly add to the story?

The war and its headlines remain the key drivers and I don’t see anything changing that dynamic for now.  I wonder if markets are prepared for an announcement that it is ending and Iran has come to terms.  I’m not suggesting that is the likely outcome, just that it would be the biggest surprise, I believe.  In the meantime, there are precious few reasons to sell the dollar outright, that’s for sure.

Good luck

Adf

No Longer Benign

Posted on by 
The war in the Gulf shows no sign
Of ending by any deadline
Some victims now bleeding
Are bonds, with yields speeding
To levels no longer benign

Already we’ve seen, efforts, great
By nations, impacts, to abate
So, price caps on gas
Worldwide came to pass
But will central banks raise their rate(s)?

Nothing of note has changed in the Iran war as the US continues to refrain from further attacks while negotiations to end the conflict ostensibly continue.  Both sides have made their demands, but from what I have read about them, neither side can accept the others wishes.  If pressed, my take is the ongoing US pause is simply allowing the Marines and 82ndAirborne to get into place for their attempt to take over and control Kharg Island and the other small islands in the Strait.  Frankly, I would not bet against their tactical success in that endeavor.  However, it is not clear how Iran will respond in that situation.  After all, if the US does control Kharg Island, that means Iran no longer controls their own revenue stream, and that is truly existential for the regime.  However, I could be completely wrong about this, which is why I am not a military strategist.

But I think it is worthwhile taking a peek at the bond market this morning.  For the first few weeks of the war, while yields edged higher, there was no indication that investors were getting terribly nervous about the longer-term impacts of the war.  However, that no longer seems to be the case.  I have several charts below showing US, UK and German 10-year yields over the past six months, and then a longer-term perspective showing those same yields over the past 20 years. 

Six months of yields

Source: tradingeconomics.com

Long-term charts (source marketwatch.com)

UK Gilts

German bunds

US Treasuries

As you can see from the first chart, yields across all three of these nations have risen sharply now in the past month.  In fact, the numbers are US (+52bps), UK (+83bps) and Germany (+47bps).  It is very clear that fixed income investors are getting worried, and reasonably so given the idea that inflation readings, at least in the short-term, are going to be much higher.  As to the longer-term view, though there is certainly a similarity amongst the movement of yields of all three nations, UK yields are currently at their highest level since the GFC, July 2008; German yields are at their highest level since the Eurozone bond crisis in 2011, but Treasury yields were higher at the beginning of this year, and 25bps higher in late 2023.  

This is not to dismiss the potential problems that may arise if government bond yields continue to rise, especially given the already extraordinarily high debt/GDP ratios that exist throughout the G10.  However, I am not prepared to concede that the US is going to collapse because 10-year yields are back at 4.50%.

What we have seen, though, almost everywhere in the world, is government attempts to cap prices on energy, whether gasoline, diesel or even electricity, to help moderate some of the obvious pain that higher energy prices are inflicting on their populations.  We have also heard a great deal from central bankers about needing to tighten monetary policy to combat the rising inflation, despite the fact that inflation is coming from a supply shock in energy rather than either excess demand or money supply.  I fear that will not work out that well if they do so, but as is often the case, central banks (and governments in general) feel they must “do something” when an exogenous event, out of their control, occurs.  Ultimately, history has shown that is when policy mistakes are made.  Here’s hoping the hostilities end quickly enough so nations don’t make those mistakes.

Away from bonds, with yields higher this morning across the board (US +5bps, Germany +5bps, UK +11bps, Japan +11bps) and the rest of the European sovereigns somewhere in between, if we turn to oil (+2.7%), WTI is pushing back up to $100/bbl this morning, which I take as an indication market participants are getting nervous things will last longer than they thought a few days ago.  You can see the chart below that oil has rallied steadily all week since the Tweet that things were going to be ending soon back on Monday.

Source: tradingeconomics.com

The more interesting price action to me, this morning, is that gold (+0.7%) is also higher this morning, which may be the first session since the first day of the attacks, where both have risen in sync.  There is a story around that Turkey sold 58 tons of gold right when things began, but even at $5000/oz, that is only about $9 billion of gold compared to average daily trading volumes of between $200 billon and $300 billion (according to Grok).  My point is that would not be enough to move markets like we have seen in gold, but it could well be a harbinger of what other nations did as well.  Again, there is no sense that the long history of gold’s role is changing here.

As to equity markets, yesterday’s weakness in the US has been followed across Europe (DAX -1.6%, CAC -1.1%, FTSE 100 -0.75%, IBEX -1.4%) but the picture in Asia was more nuanced.  While the Nikkei (-0.4%) slipped a bit, both China (+0.6%) and HK (+0.4%) managed to rally as did Malaysia, Singapore and Thailand albeit not very much.  On the downside, though, India (-2.2%) made up for the fact it was closed on Thursday, while Korea (-0.4%) and Taiwan (-0.7%) both slipped and the rest of the region edged lower by lesser amounts.  As to US futures, at this hour (7:30) they are lower by about -0.35%.

Finally, the dollar continues to be a major beneficiary of the war as the DXY is back above 100 this morning with several EMG currencies coming under greater pressure today.  We see CLP (-1.1%) feeling the pain of copper’s inability to rally at all, as well as INR (-0.6%) and MXN (-0.5%) suffering this morning.  NOK (+0.2%) continues to benefit from oil’s recent strength, and CAD (+0.1%) is holding its own on the same basis, but both the euro (-0.15%) and pound (-0.2%) are struggling as the energy problem there is a major detriment to their economies.

The only US data this morning is Michigan Sentiment (exp 54.0) while yesterday’s Jobs data continues to show that layoffs are not increasing in any meaningful way, which I believe is a result of the dramatic change in immigration policy as well as deportations.  Like so much of what is ongoing these days, old models regarding the labor market are no longer representative of the new reality on the ground.  I suspect this is true across large segments of the economy which just means that relying on econometric models will be a fraught exercise going forward.  Here is a reason to pity the central bank community as they are truly flying blind now.

And that’s all there is today.  To me, we are biding our time until the Marines land on Kharg Island and then we will see a new phase of the war.  It is a high risk, high reward venture as success would certainly reopen the Strait of Hormuz and oil prices would plummet quickly.  Failure, however, would leave Iran with greater control over that key chokepoint and potentially cause greater difficulties elsewhere in the world, not least because it would call into question the US ability to project power.  War is not only hell, but also incredibly risky.

Good luck and good weekend

Adf

The Abyss

Posted on by 
This month has seen traders dismiss
The idea that risk led to bliss
Stocks worldwide have fallen
And those who were all in
With leverage now face the abyss

But it’s not just war in Iran
That’s scrambled most everyone’s plan
The data, as well
Are heading to hell
With no central banking wise man

As I didn’t write on Friday, and it seems some things happened while I was away, I thought I might offer my views of where things stand as we enter the new week.

🤯🤯 😱😱 🤮🤮

I think that sums it up nicely.

Recapping the end of last week quickly, all the central banks left policy on hold, as was expected with all showing a more hawkish lean given the dramatic rise in energy prices, so far, and fears that food will follow shortly.  The BOE was the most obvious as rather than a 5/4 vote with 4 votes for a cut, it was 9/0 for no movement.  Adding the Thursday decisions to the previous ones from the week, and looking at the Fed funds futures market, the two tables below from cmegroup.com show the change over the past month from modest expectations of a cut at the next meeting to modest expectations of a hike, first:

Then, if we look at the aggregated probabilities, you can see that the market has priced out any cuts for 2026 at this stage, with nothing, really, until the end of 2027.

Now, here’s the thing about this pricing.  It is a current estimation based on the Fed funds futures curve and certainly is subject to massive change going forward.  However, other markets that rely on interest rate cues see this and respond accordingly.

For instance, the 2-yr Treasury note (gray line) also has seen a major yield rally as you can see in the chart below and now sits above Fed funds effective (blue line) for the first time since late 2022 when the Fed finally caught up in its race against the raging inflation of the time.

Source: tradingeconomics.com

So, inflation is once again a major worry of the markets, and investors have come to believe that central banks are not going to be coming to the rescue for their risk assets as their hands will be tied by higher energy prices driving headline inflation higher.  Of course, we all know that central banks raising rates will not adjust short term price inelasticity for energy products, although it could well cause a deep recession which would likely have an inflation impact.  But my take is, that is not their goal either.

And that is why everyone is so unsettled.  The idea that the central banks are going to come to the rescue of risk assets has been killed and now the pricing of those assets needs to rely on their own fundamentals, a much tougher task historically.  

This is especially so given the data from Thursday showed PPI much hotter than expected, which adds to the narrative that the Fed, and other central banks, are on hold, at best, if not getting itchy to hike rates.

With this in mind, we cannot be surprised that equity markets suffered greatly on Friday, as did bond markets and precious metals.  However, I believe the drivers of equities are different than those of the traditional havens of bonds and gold.  In the case of equities, high valuations, which have existed for a long time, and significant leverage, with margin debt at record highs, although as you can see from the chart below, I created from FINRA data, it turned down ever so slightly in February have started to take their toll.

And in fact, that toll on margin debt is being played out in both bonds and gold as both are clearly feeling the effects of massive deleveraging as hedge funds and CTAs all scramble to make their margin calls.  In this case, they sell what they can that is liquid, not what they want to sell, so bonds and gold fit the bill.  My take is if the war continues very much longer, we will see the margin selling diminish and soon, both gold and bonds are going to seem like pretty good places to hide.  (Now, if you want to keep up with inflation, USDi, the fully-backed inflation tracking crypto currency available at www.usdicoin.com) is going to do so far better than short-term interest rates which are almost certainly going to lag inflation for a while going forward!  Ask me about this and I am happy to discuss.)

And that’s all I have this evening.  There is a great deal of back and forth with threats from both sides in the war, and whether or not the Iranian electricity infrastructure is hit, or if their nuclear power plant at Bushwehr is hit and if so, how they retaliate remains unknown and fodder for the narrative writers.  I have no opinion other than I hope none of that happens.

In the meantime, risk reduction is likely to continue as equities suffer while the dollar maintains its value and oil is the real risk, as any indication that the military action is ending is likely to see a major downdraft there.  Unless you are a professional trader, with real capital behind you and a great market and news feed, this is not a time to play in my view. However, if I look at things and where they currently sit as Sunday night opens, gold seems to be too cheap.  For millennia it has served as the last recourse of safety, and I do not believe this war will be any different than any of the countless wars in the past.  This doesn’t mean it cannot go lower, just that it probably is approaching a place of ‘value’ especially as you can be sure that at some point later this year, every central bank will be printing as fast as they can if economies start to stutter.  One poet’s thought.

Let’s see what happens overnight and I will be back again tomorrow.

Good luck

Adf

Not Be Sublime

Posted on by 
Investors are starting to shun
The riskiest things one-by-one
So, stocks feel the pain
And bonds, too, feel strain
The dollar, though’s, on quite a run

It’s nearly two weeks since this started
And so far, no ending’s been charted
The impact o’er time
Will not be sublime
Thus, trading’s not for the faint-hearted

Another day and there is no end in sight for the ongoing military action in Iran.  US strikes continue apace and Iranian retaliation also continues, albeit at a lesser rate it seems.  However, the information from the war zone remains difficult to trust as all of it is spun for various audiences with no sense of objective truth.  As such, it is difficult to have an opinion on how long this will continue.

With that in mind, all we can do is observe market behavior and see what we can glean.  Starting with equity markets around the world, the below screenshot from Bloomberg.com this morning shows that risk is clearly off, although not catastrophically so, at least not yet.

So, weakness in the US yesterday was followed by weakness overnight in the major markets in Asia as well as in other regional markets (Korea -1.7%, India -1.9%, Indonesia -3.1%) with the rest having declined by lesser amounts.  It is important to see that all the Asian markets (and European and US markets) have fallen in the past month, but remain higher, in some cases substantially so, since this time last year.  The point is that this move can still rightly be considered corrective, rather than a dramatic change in opinion.

European bourses are demonstrating similar behavior although US futures at this hour (6:45) are slightly higher, about +0.15% across the board.  Thinking about equity markets overall, one of the main features of the US market was that it maintained a relatively high P/E ratio, no matter whether measured on a forward looking or historical basis.  Thus, a correction in equity prices, even absent the war, would not have been that surprising.  The same could not be said about European or Asian markets, which trade at much lower valuations, but then, in Europe especially, prospects for growth remain hampered by individual national domestic policies along with EU wide policies, notably in the energy sector.    Under the rubric a picture is worth 1000 words, it is not hard to understand why US equity markets dominate global markets.

Source: tradingeconomics.com

Germany has averaged -0.3% GDP growth over the past 3 years, and the EU is just above it at +0.4%.  Meanwhile, this morning’s UK GDP data showed weaker than expected outcomes, with Y/Y of 0.8% after a stagnant January.  Are US markets richly priced?  Sure, but what prospects do you have elsewhere?

Turning to bond markets, the traditional safe haven appeal of bonds, especially Treasuries and Bunds, is MIA.  While this morning, Treasuries (-1bp) and most European sovereigns (-1bp across the board) have seen prices stop declining, the picture over the past two weeks has not been encouraging.  The chart below shows the price action in both Treasuries and Bunds and, as you can see, both have seen yields rise sharply since the beginning of the month/war.  Given the ongoing stress in oil markets, and the implications that has for inflation worldwide going forward, it should not be a surprise that bonds don’t appear to offer their ordinary haven characteristics.

Source: tradingeconomics.com

The big question here, and around the world truthfully, is how will central banks respond to the rise in energy prices and subsequent rise in headline inflation?  If they try to address price pressures by raising rates in this scenario, it will almost certainly lead to recessions everywhere.  But will their models allow them to hold their policies if inflation starts to rise sharply?  It’s funny, I have been remarking how central bank policies have lost their luster recently, having been overwhelmed by fiscal policies, but suddenly, monetary policy is back in the limelight.  We shall see how they perform.

In the commodity markets, WTI (-1.3%) rallied sharply yesterday but is giving back a bit this morning.  The big headline yesterday was that Brent crude closed above $100/bbl for the first time since 2022 in the wake of Russia’s invasion into Ukraine.  Of course, that was more about the big, round number feature, than the percentage rise.  After all, is there really a difference of $98/bbl or $100/bbl in the broad scheme of things?  Oil continues to be THE driving factor in all markets right now and that is not likely to change anytime soon.  As long as the Strait remains closed to traffic, this pressure will continue to build. 

In the metals markets, both gold and silver continue to consolidate around their recent levels ($5100 in gold, $85 in silver) and it appears we are going to need another catalyst of note to get that to change.  I see no change in supply metrics, that’s for sure, but if there is a recession, silver demand may well be reduced given its industrial uses.

Finally, the dollar is king of all it surveys, at least in the FX markets.  The euro is below 1.15 (it seems like only last week that pundits were talking about the consequences of the euro trading above 1.25.  The DXY has broken above 100, although we will need to see an extension of this move to be convinced that it is going to head much higher, and USDJPY is now pushing near 160 again, which brought out comments from Katayma-san, the Japanese FinMin, about closely monitoring the yen’s value.  Of course, given the broad-based rise in the dollar, the current yen weakness cannot be seen as that troubling.

But what is a bit more interesting to me, and more definitive proof that the dollar is not about to collapse, is the coincident moves higher in the dollar vs. a number of other currencies.  Look at the chart below of ZAR (-0.15%), SEK (-0.3%) and MXN (0.0%).  Each demonstrates virtually identical trade patterns, and all of them reached their respective peaks (dollar’s nadir) on January 29th.  You may recall that was the day president Trump named Kevin Warsh as the next Fed Chair, and we saw a major reversal in stocks, gold, silver and other markets.  

Source: tradingeconomics.com

My best estimate is that FX markets are pricing in a tighter Fed at this point, which. Based on Fed funds futures, showing just one cut potentially this year in December, makes a lot of sense.  I guess it remains to be seen how other central banks will respond to the ructions in markets caused by the war, but this is the first order consequence.

Source: cmegroup.com

Turning to this morning’s data, we see a bunch as follows: 

Q4 GDP (2nd estimate)1.4%
Personal Income0.5%
Personal Spending0.3%
Durable Goods1.2%
-ex Transport0.5%
PCE0.3% (2.9% Y/Y)
Cpore PCE0.4% (3.1% Y/Y)
JOLTs Job Openings6.7M
Michigan Sentiment55.0

Source: tradingeconomics.com

As with Wednesday’s CPI data, the PCE data does not include the war, so will be dismissed.  My take is the Income and Spending numbers, and the JOLTs number will be the most impactful if they are a long way from estimates.  

And that’s where we stand.  Markets are still unsure of what to believe regarding the war, and when it comes to war, things happen that are unexpected all the time, the so-called unknown unknowns.  In the end, it is hard to bet against the dollar for right now, but that could change in an instant based on the next headline.

Good luck and good weekend

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Bonds are a Flop

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The war has now widened in scope
And though all of us truly hope
It won’t last too long
We could, there, be wrong
As such we must all learn to cope
 
So, oil, right now, knows no top
While havens like bonds are a flop
There’s no place to hide
Thus, you must decide
If trading makes sense or should stop

Carl von Clausewitz, the 19th century Prussian military strategist, is credited with describing the fog of war in his 1832 book, On War.  “…three quarters of the factors on which action in war is based are wrapped in a fog of greater or lesser uncertainty.”  This is quite an apt description of things, even now with cameras literally everywhere in the world.  Context remains difficult to understand, and, of course, there is an enormous amount of propaganda from both sides of any conflict as the protagonists attempt to sway both their own populations and those of their opponents.

I highlight this because I continue to be amazed at the certitude with which some analysts proclaim to “know” how things will turn out.  As I have written elsewhere, nobody knows nuthin right now.  With that in mind, I would highlight the IMF’s statement yesterday which added exactly zero to the conversation, “It is too early to assess the economic impact on the region and the global economy. That impact will depend on the extent and duration of the conflict.”  Now, don’t you feel educated after that pronouncement?

At any rate, with more than a full day’s trading in financial markets, perhaps we can try to assess how things are going.  The first thing to note is that many alleged haven assets are not performing up to snuff, notably Treasury bonds, Japanese yen, Swiss francs and gold.  In fact, as of this morning, the only traditional haven that is performing as expected is the dollar.

It was just over a month ago when the cognoscenti were explaining that the euro above 1.20 was indicative of the dollar’s long decline into the depths of history.  I recall someone in my LinkedIn feed asking how soon the euro would trade through 1.25 and beyond.  I would argue that timeline has been extended somewhat, if you still believe that is likely to be the case.  Rather, as you can see in the below chart, the single currency (-0.8%) is now back below 1.1600.

Source: tradingeconomics.com

There are several things weighing on the euro right now.  First is the fact that they are energy price takers for every form of energy, so not only are higher oil prices hurting the continent, but NatGas there has exploded higher as per the below chart, rising 37% today and nearly 95% since the weekend.

Source: tradingeconomics.com

Recall, Europe has been trying to wean themselves off Russian gas, have been huge buyers of US LNG but also huge buyers of Qatari LNG, and with the Strait of Hormuz effectively closed (shipowners cannot get insurance so nobody transits the Strait), this is a problem.  Adding to the European problem is the fact that their storage levels of NatGas are extremely low for this time of year, about 30%, when typical levels in early March are near 50%.  We cannot be surprised at this price action.  So, while US NatGas (+6.3% this morning, 10% this week) has risen, it is currently trading at $3.14/MMBtu.  The comparable Eurozone price is $20.28/MMBtu.  Perhaps a weaker euro is not that surprising after all.  (As an aside, one of the reasons I find it difficult to accept the weak dollar story is that the US controls its own energy destiny and given energy is life and the economy, we are fundamentally in better position to perform going forward.)

But the dollar is strong against all comers again today as per the below table from 7:10 this morning.  Will this continue?  While nobody knows, my take is there is still ample room for further strength in the buck, probably another 3%-5% before it starts to impact other things significantly.

Source: tradingeconomics.com

I think the biggest surprise for most of us is the incredibly poor performance of the bond market, which has always been seen as a safe haven.  However, this morning, that is not the case at all as you can see from the Bloomberg table below.

My take is that there is only one thing we truly know about war, it is inflationary.  While the early signs are for energy prices to rise, war is a major consumer of resources that will never be recycled and therefore will require new baseline production.  As well, governments don’t fight war on an austerity budget, so you can be sure that there will be plenty of money around.  All that leads to higher prices and that is why bond markets are feeling pain around the world this morning.  If, as President Trump has indicated, this war ends in the next 4 weeks or so, we will be able to re-evaluate the inflationary and other impacts, but while I had thought bonds were going to perform well, clearly that is not the case right now.

Turning to commodities, oil (+6.75%) continues to rise and I expect will remain well bid until the fighting stops.  The prospects for higher prices from here remain dependent on whether Iran tries to destroy other Middle East production facilities and if they are successful.  Meanwhile, in the Western hemisphere, the US, Canada, and all of Latin America are going to be pumping at full strength for now.  So, while prices may tick higher, it is unlikely we will see any supply issues here.

Metals are another surprising trade this morning with gold (-2.65), silver (-7.8%) and copper (-2.3%) all sharply lower.  Given the sharp decline in equity prices I will discuss below and given the amount of leverage that is rampant in the equity markets, I think gold is a victim of ‘sell what you can, not what you want to.’  Arguably, there is some of that with bonds as well.  In a way, though, I am more surprised about silver and copper given their criticality in fighting the war.  Both are being consumed rapidly via weapons being deployed so this is more baffling to me.  However, I do not believe the longer-term thesis in either of these metals has changed, there is a supply shortage relative to industrial usage for both with no new supply on the horizon.  As such, I do see prices here rallying over time.

Finally, the equity markets are sharply lower almost everywhere.  The below Bloomberg table shows how major markets in Asia performed overnight and how Europe stacks up at 7:30 this morning.

What it doesn’t show is that the KOSPI in Korea fell -7.25%, nor that there were sharp declines in India (-1.3%), Taiwan (-2.2%) and Thailand (-4.0%).  You will also not be surprised that US futures are pointing much lower this morning, -1.5% across the board.  Yesterday’s performance was quite the surprise, I think, but today is much more in line with what we expected.

And that’s where things stand this morning.  obviously, the war is the only story that matters, so data releases are going to be secondary for now, even Friday’s payroll report.  At some point, I expect that traditional havens will play their role, but as leveraged positions continue to get unwound, it may take a few more sessions before we see that.  If you’re trading, smaller sizes make sense.  If you’re hedging, stick to longer term fundamentals I think.

Good luck

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