Tag Archives: #UK

A Future Quite Noeth

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All eyes will be on NFP
As pundits are hoping to see
A modest result
That can catapult
The market to its apogee
 
If strong, the concern is that growth
Will strengthen and Jay will be loath
To cut rates once more
Which bulls will deplore
Implying a future quite noeth
 
If weak, then the problem for stocks
Is earnings will suffer a pox
So even if rates
Are cut in the States
The NASDAQ may still hit the rocks

 

It’s payroll day and especially after yesterday’s day of respect for the late President Carter closed equity markets in the US, investors are anxious to get back to business.  Here are the latest consensus estimates for the key figures to be released

Nonfarm Payrolls160K
Private Payrolls135K
Manufacturing Payrolls5K
Unemployment Rate4.2%
Average Hourly Earnings0.3% (4.0% Y/Y)
Average Weekly Hours34.3
Participation Rate62.8%
Michigan Sentiment73.8

Source: tradingeconomics.com

As well, there will be annual revisions to the household report today, which is the portion of the process that calculates the Unemployment Rate.  Next month we will see the annual revisions to the NFP, where estimates are already circulating that the number of jobs created in 2024 will be revised down by more than 1 million, nearly one-half of the claimed number (~2.2 million) created.

But ultimately, the reason this data point gets so much press is that it is half of the Fed’s mandate and so is closely watched by the FOMC as they consider any policy stance.  Yesterday, St Louis Fed president Musalem became the seventh or eighth Fed speaker since the last meeting to explain that more caution was warranted as the Fed tries to reduce what they still believe is a modest tightening bias.  “… [rate reductions] have to be gradual – and more gradual than I thought in September,” according to Musalem.  So, caution remains the watchword for every member of the FOMC and accordingly, the market is pricing just a 5% probability of a rate cut later this month.

The thing that has really changed over the past several months is the market’s reaction function to the data.  Part of this is based on the fact that it appears the Fed’s reaction function has changed a bit, and part of this is because the economic situation remains so confusing.

Regarding the Fed, given the fact that the data since they started cutting rates in September has been quite robust and given the fact they no longer have a political/partisan motive to cut rates, it strikes me it will be far harder for Powell and friends to justify further rate cuts from here.  After all, if GDP is growing at 3.0% and inflation is running at 3.3%, absent all other information, that data would truthfully argue for rate hikes.  However, there remains a large camp of analysts that continue to expect a significant slowdown in economic activity, with a number of well-respected voices claiming that we are already in a recession and have been in one since sometime in 2024.  

My view is that this confusion remains best explained by the concept of the K-shaped recovery where a smaller portion of the population, notably those with assets and investments in the markets, have been huge beneficiaries of Fed policies as they not only have seen their portfolios climb in value, but their cash is earning a nice return.  Meanwhile, a much larger percentage of the population, although a group that receives far less press from the financial reporters, continues to struggle given still rising prices and less overall opportunity for advancement.  This is the genesis of the labor strife we have seen, but there are many who remain left behind.  The problem for the Fed is they don’t really see this second cohort as their constituents, at least based on their policy actions.

As to today’s release, if we look at the recent Initial Claims data, it is consistent with a stronger number rather than a weaker one.  However, from a market perspective, I believe that a strong NFP number, something like 200K, will see a risk sell-off as the market continues to remove pricing for any rate cuts in 2025.  This will hurt stocks and likely bonds, although it will help the dollar and, surprisingly, commodities, as the market is likely to see increased demand forthcoming.

Elsewhere, aside from the wildfires in LA, which are a terrible tragedy, the other story in markets today revolves around the ongoing, slow motion disintegration of any remaining credibility in the UK government and its ability to address the many problems there.  Gilt yields continue to rise sharply, although I continue to hear many rationales as to why this is NOT like the October 2022 Gilt crisis.  Alas, while certainly the speed of this decline in Gilts is not quite as dramatic as we saw back then, the duration of the problem is far greater, and we have moved further now than then.  As you can see from the below chart, Gilt yields have risen 110bps since the middle of September, outpacing even Treasury yields and 10yr Gilts now yield 15bps more than Treasuries.  

Source: tradingeconomics.com

In fact, UK 10-year yields are the highest in the G10, although in fairness, they are not yet approaching levels like Mexico (10.6%), Brazil (14.75%) or Turkey (26.4%).  Perhaps Chancellor Reeves has those targets in mind.

OK, let’s see how markets behaved in the lead-up to the data this morning.  There was no joy in Mudville Asia last night as the Nikkei (-1.05%) slid amid new stories that the odds of a BOJ rate hike in two weeks are rising, while Chinese shares (Hang Seng -0.9%, CSI 300 -1.2%) were also under pressure amid news that the PBOC would stop buying bonds (ending QE) and additionally might be selling some to reduce liquidity in Hong Kong as they attempt to slow the decline of the renminbi.  The rest of the region was similarly under pressure across the board. 

In Europe, the picture is more nuanced with the DAX (+0.4%) and CAC +0.3%) showing some modest gains after slightly better than expected French IP data.  However, the FTSE 100 (-0.4%) and other continental bourses (IBEX -0.9%) are not quite as positive, with the FTSE clearly feeling pressure from the overall negative sentiment on the UK, while mixed data elsewhere is undermining any investor sentiment.  US futures at this hour (7:15) are pointing lower by about -0.25% across the board.  Fears of a strong number?

In the bond market, Treasury yields continue to climb, as they are holding onto yesterday’s rise of 5bps and this morning we are seeing European sovereign yields all creep higher by 1bp to 2bps.  JGB yields also rose 2bps overnight as part of that BOJ rate hike story.  In fact, the only market that didn’t see yields rise is China, where they remain within 2bps of their recent all-time lows

In the commodity markets, oil (+3.2%) is skyrocketing as continued cold weather increases heating demand while the reduction in inventories in Cushing, Oklahoma (the main point for NYMEX contract settlements) has raised concern over available supply of crude.  Meanwhile, metals prices continue to climb steadily with gold (+0.3%) continuing its run alongside silver (+0.8%) and copper (+0.45%).  The demand for “stuff” remains strong as nations around the world slowly lose confidence in government bonds as an effective store of value.

Finally, the dollar is, net, little changed this morning with some gains and some losses although few large moves.  On the dollar’s plus side we see KRW (-0.5%), ZAR (-0.55%) and BRL (-0.35%) while the yen and renminbi have both seen modest gains (+0.1%) on the back of the liquidity reduction stories in both nations.  However, we must keep in mind the dollar, as measured by the DXY, remains above 109 and continues to strongly trend higher.  My take is the highs seen in autumn 2022 are the next target, so look for the euro to sink below parity and the pound well below 1.20, probably 1.15, before too long.

There are no Fed speakers on the schedule today, although I imagine we will hear from somebody after the data since they cannot seem to shut up.  However, after today, they head into their quiet period ahead of the next FOMC meeting, so until then we will need to rely on Nick Timiraos from the WSJ to understand what Powell is thinking.

While nothing is that clear, and we could easily see a weak NFP report, my take is we are far more likely to see a strong one with stocks and bonds selling off and the dollar rising further.

Good luck and good weekend

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Quite a Fuss

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Inflation is still somewhat higher
Though currently nor quite on fire
Thus, further reductions
In rates may cause ructions
In markets, which we don’t desire

 

“With regard to the outlook for inflation, participants expected that inflation would continue to move toward 2 percent, although they noted that recent higher-than-expected readings on inflation, and the effects of potential changes in trade and immigration policy, suggested that the process could take longer than previously anticipated. Several observed that the disinflationary process may have stalled temporarily or noted the risk that it could. A couple of participants judged that positive sentiment in financial markets and momentum in economic activity could continue to put upward pressure on inflation.” [emphasis added]

I think this paragraph from the FOMC Minutes was the most descriptive of the evolving thought process from the committee.  Since then, we have heard every Fed speaker discuss the need for caution going forward with regard to further rate reductions although to a (wo)man, they all remain convinced that they will achieve their 2% target while still cutting rates further, just more slowly.  While today is a quasi-holiday, with the Federal government closed along with the stock exchanges, although banks and the Fed are open and making payments, I anticipate activity will be somewhat reduced.  This is especially so given tomorrow brings the NFP data which will be closely monitored given the recent strength seen in other economic indicators.  If that number is strong, I anticipate the market will reduce pricing for future rate cuts towards zero from this morning’s 40bps total for 2025.  This, my friends, will serve to underpin the dollar going forward.

In England, there is quite a fuss
As traders begin to discuss
Can Starmer and Reeves
Address what aggrieves
The nation, or are they now Truss?

The situation in the UK seems to be going from bad to worse.  Even ignoring the horrifying stories regarding the cover-up of immigrant grooming gangs and their actions with young girls, the economic and policy story is a disaster.  While the exact genesis of their fiscal issues may not be certain, the UK’s energy policy, where they have doubled down on achieving Net Zero carbon emissions and continue to remove dispatchable power from their grid, is a great place to start looking.  UK electricity prices are the highest in Europe, even higher than Germany’s, and that is destroying any ability for industry to exist, let alone thrive.  The result has been slowing growth, reduced tax receipts and a growing government budget deficit.

Some of you may remember the Gilt crisis of September/October 2022, when then PM Liz Truss proposed a mini-budget focused on growth but with unfunded aspects.  Confidence in Gilts collapsed and pension funds, who had been seeking sufficient returns during ZIRP to match their liabilities and had levered up their gilt holdings suddenly were facing massive margin calls and insolvency.  The upshot is that the BOE stepped in, bought loads of Gilts to support the price and PM Truss was booted out of office.

While the underlying issues here are somewhat different, the market response has been quite consistent with both Gilts (+5bps this morning, +34bps in past week) and the pound (-0.6% this morning, -2.0% in past week) under significant pressure again this morning.  Unlike the US, with the global reserve currency, the UK doesn’t have the ability to print as much money or borrow as much money as they would like to achieve their political goals.  In fact, the UK is far more akin to an emerging market than a G7 nation at this stage, running a massive fiscal deficit with rising inflation and a sinking currency amid slowing economic growth.  There are no good answers for the BOE to address these problems simultaneously.  Rather, they will need to address one thing (either inflation and the currency by raising rates, or economic activity by cutting them) while allowing the other problem to become worse.  

It is very difficult to view this situation as anything other than a major problem for the UK.  While it occurred before even my time in the markets, back in the 1970’s, the UK was forced to go to the IMF to borrow money to get them through a crisis.  There are some pundits saying they may need to do this again.  For some perspective, the chart below shows GBPUSD over the long-term.

Source: tradingeconomics.com

The history is the pound was fixed at $2.80 at Bretton Woods and then saw several devaluations until 1971 when Nixon closed the gold window, and Bretton Woods fell apart.  The spike lower in the 1970’s was the result of the UK policies driving them to the IMF.  The all-time lows in the pound were reached in 1985, when the dollar topped out against its G10 brethren, and that resulted in the Plaza Accord.  But since then, and in truth since the beginning, the long-term trend has been for the pound to depreciate vs. the dollar.  

It continues to be difficult for me to see a strong bull case for the pound as long as the current government seems intent on destroying the economy.  FX option markets have seen implied volatility spike sharply, with short dates rising from 8% to 13% in the past week while bids for GBP puts have also exploded higher.  Meanwhile, the gilt market cannot find a bid.  Something substantive needs to change and don’t be surprised if it is political, with Starmer or Reeves, the Chancellor of the Exchequer, finding themselves out of office and a new direction in policy.  However, until then, look for both these markets to continue lower.

I apologize for the history lesson, but I thought it best to help understand today’s price action in all things UK.  And that’s really it for discussion.  Yesterday’s mixed US session was followed by weakness in Asia (Nikkei -0.95%, Hang Seng -0.2%, CSI 300 -0.25%) with the rest of the region also lower.  However, this morning in Europe other than the DAX, which is basically unchanged, modest gains are the order of the day.  Surprisingly, the FTSE 100 (+0.55%) is leading the way higher, but given the large majority of companies in this index benefit from a weaker pound, perhaps it is not so surprising after all.

In the bond market, Treasury yields are 3bps lower this morning, although still near recent highs above 4.65%, while European sovereigns continue to rise as the global interest rate structure climbs amid growing concerns nobody is going to adequately address the ongoing inflation.  Even Chinese yields rose 2bps despite CPI data showing deflation at the factory gate continues and consumer demand remains moribund.

Commodity prices are modestly firmer this morning with oil (+0.2%) stabilizing after a sharp decline yesterday on supply concerns after a large build of product inventories in the US.  Metals prices continue to be supported (Au +0.4%, Ag +0.8%, Cu +1.2%) despite the dollar’s ongoing strength as it appears investors want to hold real stuff rather than financial assets these days.

Finally, the dollar continues to climb with most currencies sliding on the order of -0.2% aside from the pound mentioned above and the yen (+0.3%) which seems to be acting as a haven this morning.  Nonetheless, this remains a dollar focused process for now.

There is no economic data to be released today although I must note that Consumer Credit was released yesterday afternoon and fell -$7.5B, a much worse outcome than expected.  As you can see from the below chart, declining consumer credit, while not completely unheard of, is a pretty rare occurrence.  You can clearly see the Covid period and the best I can determine is the December 2015 decline is a data adjustment, not an actual decline.  The point to note, though, is that despite lots of ostensibly strong economic data, this is a warning.

Source: tradingeconomics.com

I keep looking for something to turn the tables on the dollar, but for now, it is hard to make the case that the greenback is going to suffer in any broad-based manner.  Tomorrow, though, with NFP should be quite interesting.

Good luckAdf

Our Future’s Austere#debate,#china,

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This evening there’ll be a debate
And markets are willing to wait
To see if the polls
Will change who controls
The future, and all of our fate
 
Until then, it seems pretty clear
Investors are waiting to hear
Amid all the lies
If taxes will rise
And whether our future’s austere

 

It seems that all eyes have begun to focus on this evening’s debate between former President Trump and Vice-president Harris, with both sides bombarding every source of information available to the average person with their own spin.  Within the market context, the debate is about which candidate’s policies will be better for the economy and by extension equity markets.  As I am just a poet, this is all far above my pay grade.  Trying to be somewhat objective (and I’m sure you have figured out I lean toward the traditional conservative view of less government is better), from what I have read, neither side paints a particularly enticing picture.  

Tariffs have never proven effective, but the concept of taxing unrealized capital gains is abhorrent, and if enacted would be extremely detrimental to the nation.  Ultimately, I think the phrase, energy is the economy, is one to keep in mind as understanding that idea leads to an understanding of how policy choices will impact economic activity over time.  One need only look at Germany’s economic suicide following their Energiewende policy that has raised the price of electricity dramatically (it is 3x US prices) and led to a slow-motion collapse of the nation’s once strong manufacturing sector, to get a glimpse of the future without cheap and abundant energy.

So, with the Fed in their quiet period, let’s turn our attention overseas for any other news of note.  Chinese trade data was released overnight and showed a further increase in their trade surplus ($91B), news which probably did not brighten President Xi’s day as imports remain incredibly weak, a strong signal that the domestic economy is still stumbling along poorly under the weight of the ongoing collapse in the property bubble there.  The problem was highlighted by Exports growing 8.7% while Imports grew just 0.5%.  Chinese markets were largely unimpressed with this as the CSI 300 rose just 0.1% (although that is better than many of its recent sessions) and the renminbi slipped 0.1% despite a broader trend of modest dollar weakness.

The other notable data was from the UK where the employment situation continues to improve, with the Unemployment Rate falling to 4.1% while wages keep growing at 5.1% and there was a significant uptick in Employment by 265K with all of that data at least as good as expectations with some exceeding them.  When combining the resilience of the employment situation with the fact that inflation remains well above target in the UK, it continues to be difficult to understand the near desperation that the BOE has to cut interest rates.

In fact, that last comment can be applied to the US as well.  A look at the data shows that the job market, while not as robust as it had been last year, remains pretty solid, at least according to the BLS and the recent NFP report, while inflation, no matter how it is measured, remains well above the Fed’s 2.0% target.  In fact, the Atlanta Fed’s GDPNow data moved higher after the NFP report and is now sitting at 2.5% for the current quarter, which would follow the 3.0% Q2 measure.  Again, other than Powell’s promise to cut rates at Jackson Hole, it is not clear the data is pointing to that, at least not the data on the surface.  In fact, Torsten Slok, a well-known economist at Apollo Group, has put out a very interesting compilation of very current data showing that the economy seems to be doing fine.  My point is from the Fed’s perspective, this incredible desire to cut rates seems odd.

But that is the reality, central banks everywhere really want to cut rates, and come Thursday, the ECB will be the next to do so.  The question of 25bps or 50bps for the Fed next week seems almost moot compared to the fact that the market is pricing in 250bps of cuts by the end of next year.  Here’s the problem with that pricing; if the Fed does stick the soft landing, that seems like far too much policy ease without driving a significant uptick in inflation screwing up the soft landing theme.  However, if the economy does fall into recession, they will cut a lot more than that, probably on the order of 350bps to 400bps (Fed funds falling to 1.50% – 2.00%).  And one more thing to remember, QT continues in the background as the Fed gradually reduces the size of its balance sheet.  But can they continue to remove that liquidity while cutting rates as much as the market anticipates?  That feels like a very tough task and in truth, if the Fed is cutting rates, I think we are more likely to see QT turn into QE than anything else.  

So, regardless of the lack of activity today, there is much still to come.  As to today, let’s survey the rest of the markets outside China.  After yesterday’s solid rallies across US equity indices, other than Japan (-0.2%) and Korea (-0.5%), the rest of Asia had solid performances with gains ranging between 0.2% (HK) and 0.75% (Indonesia).  Europe, too, is mixed this morning with some modest gains (CAC, IBEX) and some modest declines (DAX, FTSE 100) with the latter more surprising given the solid employment data.  Perhaps that is the market showing concern the BOE will not cut rates as much as previously expected.  As to US futures, they are little changed at this hour (7:50).

In the bond market, Treasury yields are higher by 1bp this morning and we have seen similar rises across the entire European sovereign market.  Of more interest is the fact that the US 2yr-10yr yield curve is now positively sloped by 3bps this morning, with the long inversion finally having ended.  At least at those maturities.  But if you look at the 3mo (4.98%) – 2yr (3.68%) spread of -130bps, that is dramatically inverted with the market pricing in a huge amount of Fed rate cuts coming ahead.  I cannot help but look at that and be confused about equity analysts’ collective view of significant profit growth going forward.  One of those seems wrong.

In the commodity markets, oil (-1.2%) which had a nice bounce yesterday on concerns over Hurricane Francine hitting the Gulf of Mexico tomorrow, has given it all back after the weaker Chinese consumption data.  Meanwhile, metals prices, which also rallied yesterday amid the general good feelings, are little changed overall this morning.

Finally, the dollar is little changed net this morning as the euro has edged down a few pips while the pound has rallied a similar amount.  In fact, in the G10, only NOK (+0.45%) is showing any movement of substance after lower-than-expected inflation data has reduced the probability of further rate cuts by the central bank there.  Amazingly, in the EMG bloc, movements have been even smaller with really nothing of note to discuss amid overall changes of +/-0.2% or less.

On the data front, the NFIB Small Business Optimism Index was released earlier this morning at 91.2, more than 2 points below last month and expectations and an indication that the small business community remains concerned about future economic activity.  There are no speakers and no other data this morning, so I expect the currency markets to do little until after the debate this evening.  If one candidate is particularly effective, we may see some movement, but otherwise, I sense that people are awaiting tomorrow’s CPI for the next catalyst to make a move.

Good luck

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A Joyous Occasion

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For those of a certain persuasion
Wednesday was a joyous occasion
Though CPI rose
The doves did propose
That rate cuts complete their equation
 
They claim that the speed of its rise
Is slowing, so Jay should surmise
It’s time to cut rates
Cause everyone hates
When stocks don’t make further new highs

 

Yesterday’s CPI reading was, on the surface, slightly softer than markets had been expecting.  The headline reading of 2.9% was the slowest increase Y/Y since March 2022.  Of course, back then we were repeatedly told inflation was transitory.  However, looking at the chart below, created by wolfstreet.com, it seems pretty clear that the main driver of the recent decline in the CPI readings has been Durable Goods.

A graph of a number of lines Description automatically generated with medium confidence

I guess it’s possible that durable goods prices continue to deflate going forward, but that seems unlikely, at least based on the historical record.  While the auto industry, a key segment of the durable goods data, has obviously struggled lately, with significant unsold inventories of EV’s building up and dealer incentives to sell them driving prices down, if you’ve looked for a new washer/dryer or refrigerator lately, I haven’t seen the same price action for those goods.  As to the largest driver of the CPI readings, the shelter component, those numbers were higher than last month and more in line with the overall trend we have seen there for the past several years.  Owners Equivalent Rent, the biggest piece of this puzzle, rose 0.4% in July, just what it has been doing for the previous two plus years prior to the June reading.

In the end, while it was nice to see a headline print below 3.0%, it is not clear to me that inflation is defeated.  Other than the fact that Powell essentially promised he would be cutting rates next month, the data released since the last meeting is not screaming out for more support.  Certainly, the employment report was softer than the forecasts, but it was not indicative that we are in a recession.  And the CPI report, while ever so slightly softer than forecast, is also not a clear signal that things are collapsing in the economy.  I’m pretty confident that Powell will cut next month, but absent some really awful August data, released in early September ahead of the next FOMC meeting, it seems like 25bps is all we should expect.  Even the Fed funds futures market is slowly turning toward that view with the probability of a 50bp cut falling to 37.5% this morning.

The other news of note last night was the monthly Chinese data dump which was, on the whole, not very inspiring.  The best news was that Retail Sales there rose 2.7% Y/Y in July, slightly more than expected.  However, IP and Fixed Asset Investment were both weaker than forecast and weaker than last month although higher than Retail Sales.  Meanwhile, Housing prices continue to decline, -4.9% Y/Y, and the Unemployment Rate ticked up to 5.2%.  As yet, there has been no significant commentary from the government, but the ongoing weakness has encouraged some traders and investors to expect that President Xi will authorize some much larger stimulus in the near future.  At least that’s the story behind the rally in the CSI 300 (+1.0%) last night, because there are few other highlights from the Middle Kingdom.

With this in mind, and as we await this morning’s US data releases, let’s tour the markets to see how things played out after the modest US equity rally yesterday.  Aside from China, in Asia Japanese stocks did well (Nikkei +0.8%) although Hong Kong did not go along with the Chinese story.  Australian employment data was released, arguably a touch better than expected but that good news reduced the chances for a rate cut so equities there only edged higher by 0.2%.  As to the rest of the region, there were some gainers (Korea, New Zealand, Singapore) and some laggards (Taiwan, Indonesia).  

In Europe this morning, the story is one of a seeming lack of interest with no major market having moved more than 0.2%, whether higher or lower, on the session.  On the data front there, the UK GDP data was just a touch softer than the forecast, and the Y/Y output of 0.7% shows that problems remain in the economy.  It will be interesting to see if the new government there can adopt policies that help rejuvenate the nation.  As to the FTSE 100, it is basically unchanged on the day, arguably tension between weaker growth prospects clashing with hopes for rate cuts to support things.  Meanwhile, on the continent there was nothing of note and no major movement.  And lastly, US futures, at this hour (7:00), are little changed awaiting the US data.

In the bond market, Treasury yields, after a little early gyration following the CPI release, basically closed the day unchanged and remain at those levels this morning.  the yield curve remains mildly inverted, just -11bps this morning, but it seems it will require the Fed to actually cut rates, or much worse economic data, to get that process complete and normalize the curve.  In Europe, sovereign yields are largely unchanged, or perhaps higher by 1bp this morning amid very little activity.  Also, a quick look at JGBs shows that while the yield edged up 1bp overnight, the level is still just 0.82%.  I would contend that any ideas of a quick normalization of interest rates in Japan are fading away.

In the commodity space, oil (+0.85%) is rebounding after data showed net draws across all products yesterday.  Obviously, the Iran/Israel situation remains live, but it feels like markets are losing interest in that story.  As to the metals, gold (0.4%) is recouping yesterday’s losses and both silver and copper are firmer this morning, not so much on the demand story, but more on the supply story with potential strikes at key mines in Chile and Peru.

As to the dollar, it is little changed, net, on the day, although it is no surprise to see the commodity bloc performing well (AUD +0.5%, ZAR +0.5%, NOK +0.4%).  But away from those currencies, the euro is unchanged, though the pound (+0.3%) seems to be benefitting from the GDP data.  The yen, too, is unchanged on the day while CNY (-0.2%) is under pressure from the weak data there.  Again, I will note that CNY’s volatility has definitely increased over the course of the past several months.  Partly this is because all currency volatility has moved higher, but I believe there is some real China specific aspect to this change.  Beware as this could continue going forward.

On the data front, this morning brings a bunch here at home:

Initial Claims235K
Continuing Claims1880K
Retail Sales0.3%
-ex autos0.1%
Empire State Manufacturing-6.0
Philly Fed7.0
IP-0.3%
Capacity Utilization78.5%

Source: tradingeconomics.com

You may recall that last week’s Initial Claims number was seen as a savior when it printed a bit lower than forecasts.  However, if the Unemployment Rate is truly heading higher, it would seem that we should see this number resume its climb.  Right now, it is not clear to me if good news is good or bad and vice versa. Generically, the narrative still wants to push for as many rate cuts as quickly as possible, I think, but if the data starts to collapse, that will not be a positive either.  I suspect that Retail Sales is today’s key release.  A strong number there will further reduce the probability of a 50bp cut in September and may weigh on equity markets.  

We also hear from St Louis Fed President Alberto Musalem this morning, one of the newer members of the FOMC who has not spoken much.  However, he appears to be more on the hawkish side thus far.  In my view, markets are looking for reasons to continue to push equities higher but are not getting all the love they need.  The problem is that it is not clear what the right medicine for that is right now.  Strong data may support the economy but reduces the probability of rate cuts, or at least the amount of rate cutting that will come.  As to the dollar, it has been under some pressure of late and I think it will be very clear that weak data will encourage dollar selling and vice versa.

Good luck

Adf

A Shocking Surprise

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On Wednesday the data was dreck
On Friday, twas more of a wreck
The read’s now that growth
Is set for more slowth
Will this break the Fed’s bottleneck?
 
Meanwhile, in a shocking surprise
In France, tis the Left on the rise
But no party there
Is willing to share
Their power and reach compromise
 
And while day-to-day matters greatly
The populists, worldwide, are lately
Ascending to power
And ready to shower
Their voters with cash profligately

 

This morning, the world is a very different place than it was when I last wrote.  Broadly speaking there are three key stories of note; US data was much weaker than expected, the French election surprised one and all with the coalition of hard-left parties winning the most seats, although no group is even close to a majority of the French parliament, and the questions over President Biden’s capacity to remain on the job, let alone his ability to be president for the next four years, have been coming fast and furious from the mainstream media, many Democrats in Congress and the Democratic donor base.

So, let’s address them in order.  On the US data front, arguably the best release was the Trade Balance printing at a slightly smaller deficit than forecast by the Street.  Otherwise, ISM Services was miserable at 48.8, Factory Orders fell -0.5%, -0.7% ex Transport, and Initial and Continuing Claims both rose to new high levels for the cycle.  And that was just Wednesday.  On Friday, while the headline NFP number did beat forecasts, once again, there were major revisions lower to the past 3 months, -111K, the Unemployment Rate rose to a new high for the cycle at 4.1%, its highest level since November 2021 and a continuation of the recent uptrend in the data.  A look at the chart below seems to show a defined trend higher in the Unemployment Rate, and as I explained last week, this is a statistic that tends to have momentum once it gets going.  I would argue this number is going to continue to climb higher as the year progresses.

Source: tradingeconomics.com

As well, the biggest piece of the report was an increase of 70K Government jobs, compared to just 136K Private sector jobs and a loss of -8K in Manufacturing.  The one thing we know is that government jobs do not add to economic growth as they are the least productive of all.  

The upshot is that based on the data from Wednesday and Friday, the story of still strong growth in the US has clearly been called into question.  Will Powell, who testifies before Congress this week, pay homage to the weaker data and hint that perhaps higher for longer has reached its sell-by date?  While this is only one set of data, and he has been adamant that he needs to see several months of data, the market is becoming more convinced that a September rate cut is coming as the Fed funds futures probability of that cut has risen to 75%.  It should be an interesting week given both the CPI release and the Powell testimony.

On to the French and what was truly a shocking outcome, at least on one level.  After the first-round last week, the abject fear by the press in France, and all of Europe, of the idea that a right-wing government could come to power in a key European nation resulted in the numerous parties on the Left working with President Macron’s centrists to try to prevent any such thing from happening.  As such, they strategically pulled candidates from different seats in order to prevent splitting the vote and allowing Marine Le Pen’s RN party from achieving a majority.  And they were effective in that.  Alas, they now have a completely unworkable setup where no party has anywhere close to a majority and so passing any legislation will be nigh on impossible.  

Jean-Luc Melenchon, the Left’s most well-known proponent, and leader of a sect called France Unbowed, has declared that he wants his party’s agenda implemented full-on.  That means reducing the retirement age, raising wages and establishing price controls on power and energy as well as expanding wind and solar power.  Of course, the math on that won’t work, even if they raise taxes, but that certainly never stopped a populist once in office.  

Interestingly, while on the surface it would have been easy to conclude that French OATs would see yields rise vis-à-vis German Bunds as fears of larger government deficits build, that has not yet been the case.  In fact, this morning, yields across Europe are little changed as bond traders and investors seem to be ignoring the situation.  The rationale here is that given no group has a majority, the probability of having any party’s wish list implemented by parliament is vanishingly small.  The most likely outcome is a year of muddling through, with no decisions of any substance made and another election held next summer.  (By law, President Macron must wait one year after an election to call a second one.)  In fact, it will be very interesting to see how a prime minister will even be elected in parliament as it seems unlikely that any individual will have support of a majority of the chamber. 

As to the other potential impacts of this election, neither French equities nor the euro have shown any substantive movement as traders in both these spaces see the same situation, a very low probability of any substantive policy changes given the lack of parliamentary leadership.  Ultimately, while the political ramifications in France are large, the economic ones are not as obvious yet.

This is different than in the UK, where Keir Starmer and his Labour party swept to victory as widely expected.  In the UK, Labour runs the show now and so will be able to implement whatever policies they deem appropriate.  So far, there has been little in the way of concern demonstrated by market participants for UK assets either, but I fear the risk here is greater as the policy prescriptions that Starmer favors are likely to have a much larger negative economic toll.

Finally, in what must be THE most surprising aspect of the presidential election cycle in the US, former President Trump is NOT the major topic of conversation.  Rather, in the wake of the debate 10 days ago, the only topic is President Biden’s fitness for office now, and in the future.  This is certainly not a good look for the US, especially with a key NATO meeting this week in Washington D.C., but it is the current situation.  Thus far, US risk assets have ignored all this, arguably because the fiscal spending spigot has not been turned off.  But it is not hard to imagine that there are myriad problems ahead as Secretary Yellen tests just how many bonds the US can issue and still find buyers.

So, with all that remarkable news in our memory banks, let’s look at how markets are behaving this morning and what happened overnight.  Ironically, it seems Asian investors are the ones most upset by the European elections of last week as equity markets throughout the time zone fell.  The Hang Seng (-1.55%) was the laggard, although China (-0.85%) and Australia (-0.8%) also performed quite poorly and the Nikkei (-0.3%) was a star by comparison.  There was very little in the way of economic data to drive things here, so this seems merely to be part of the usual ebb and flow of markets.  The real surprise, though, is in Europe where equity markets are higher across the board.  Despite the pressures for more spending and higher taxes that will come from both France and the UK, the CAC (+0.45%) and the FTSE 100 (+0.3%) are nonplussed by the situation.  In the UK, as laws are implemented, I expect there will be a bigger reaction, but in France, perhaps the view that there is gridlock which will prevent any new legislation of note, means equities can run higher.  As to the US, futures markets at this hour (7:00) are basically unchanged.

As mentioned above, bond yields throughout Europe have been limited in their movement while Treasury yields have rebounded 2bps from last week’s declines.  While I was out, the weak data certainly encouraged bond investors to increase allocations as visions of a Fed rate cut grow.  For now, the bond markets are not signaling any concerns over the electoral outcomes.  My take is that may be appropriate for France and the continent, but I would be wary of UK Gilts given the likelihood of a downturn in the fiscal situation as more spending is implemented by parliament.

In the commodity markets, the end of last week saw sharp rallies in the metals markets, perhaps on those fears of a RN electoral victory in France, or perhaps on expectations of quicker Fed rate cuts, but this morning, commodities across the board are softer, with oil (-1.3%) leading the way, although WTI remains well above $82/bbl.  As to the metals, both precious (Au -0.7%, Ag -0.7%) and industrial (Cu -0.2%, al -0.1%) are giving back some of those gains.

Finally, the dollar is somewhat higher than it closed on Friday, although not very much.  In the G10, NOK (-0.5%) is suffering on oil’s decline which has dragged SEK (-0.4%) along with it.  The yen (-0.1%) which fell to near 162 vs. the dollar last Wednesday recouped some of those losses into the weekend but seems to have bounced with 160.00 now showing technical support in USDJPY.  In the EMG bloc, HUF (-0.8%) is the laggard as despite a lack of data, it seems markets are looking at the right-leaning politics of PM Orban and see continued friction between Hungary and the rest of the EU, specifically when it comes to subsidy payments.  KRW (-0.5%) is softer as the government’s efforts to expand trading hours in the currency have not yet borne fruit although it is still early days.  They are trying to improve onshore currency trading in order to allow more convertibility for equity investors and thus get Korean stock markets included in more global indices.

On the data front, while the calendar is not packed, it is impactful.

TodayConsumer Credit$10B
TuesdayNFIB Small Biz Optimism89.5
 Powell Testimony 
WednesdayPowell Testimony 
ThursdayInitial Claims240K
 Continuing Claims1860K
 CPI0.1% (3.1% Y/Y)
 -ex food & energy0.2% (3.4% Y/Y)
FridayPPI0.1% (2.3% Y/Y)
 -ex food & energy0.2% (2.5% Y/Y)
 Michigan Sentiment68.5
Source: tradingeconomics.com

In addition to Powell, 5 other Fed speakers are slated, but clearly all eyes will be on Powell.  And the CPI reading.  After last week’s soft data, there is a growing expectation that price pressures are going to fall back further and allow the Fed to cut rates.  Certainly, if CPI prints soft, I expect to see a rally in risk assets, but we must wait to hear Powell’s spin ahead of those numbers.

Net, the market is seemingly turning toward a more dovish approach with visions of rate cuts coming fast and furious once they get started.  That seems excessive to me, but for now, it is hard to like the dollar’s status as rate cut expectations build, especially given the market has ignored potential problems elsewhere.

Good luck

Adf

Death Knell

Posted on by

If CPI data today
Is hot, then get out of the way
Amid the death knell
Investors will sell
Stocks for which they did overpay
 
But if, instead, CPI’s cool
The thing to expect, as a rule
Is risk asset rallies
And FinTwitter tallies
Of profits o’er which some will drool

 

There are some who believe that today’s CPI data will not lead to much price action at all.  The thesis seems to be that everybody is too focused on the outcome, and that any hot print will be immediately talked away by folks like Nick Timiraos in the WSJ and every other administration official (Yellen, Brainard) or folks like Larry Summers or Paul Krugman (although I don’t think anybody listens to him anymore).  The idea is that the government will not allow things to get out of control ahead of the election and so inflation will be denied and the path to a June rate cut will not be denied.  It is easy to ascertain that the FOMC is anxious to cut rates, and I’m sure there is intense pressure on them to do so behind the scenes from the administration.  After all, why would they all explain that inflation remains hotter than they expected, but think they are going to cut anyway?  The one thing I am willing to wager is that if we see a hot number, there will be an article in the WSJ before lunchtime explaining that it doesn’t change anything.

On the other hand, if the data comes in cooler than expected, one would have to believe that we are going to see risk assets once again take the bit in their proverbial mouth and run higher again.  Animal spirits remain quite robust and the modest down days from Friday and yesterday are nothing compared to what we have seen.  Very likely, some risk has been lightened up, but I would argue there is very little change of heart at this point.

One thing, though, that is very important is if the market behavior does not follow the data release.  For instance, if a hot print results in a short-term dip and then a reassertion of the bull trend, that is hugely positive for risk assets for the next several weeks I would think.  Or certainly up until the FOMC meeting.  Similarly, if a cool number results in a short-term pop in futures but a continued sell-off over the session, that would be a signal that a correction has begun.  A market that cannot rally on good news is one that is exhausted.

For good order’s sake, let me repeat the current expectations: Headline (0.4%/3.1% Y/Y) and Core (0.3%/3.7% Y/Y).  Prior to the CPI data, we have already seen the NFIB Small Business Optimism index which fell to 89.4, a point worse than expected.  Interestingly, the largest concern amongst this cohort of business owners is rising inflation, which has replaced ability to find quality employees at the top of the list of issues. This is not the type of data the Fed wants to see, rising inflation expectations alongside a softer labor market. But in the end, it’s the CPI data that is going to matter today.

Aside from that, or perhaps more accurately because everyone is so focused on that, there has been very little else ongoing in markets overnight.

After a very lackluster session in the US yesterday, last night saw Japanese stocks essentially unchanged with the big activity in Hong Kong (+3.0%) despite the largest listed property company, Vanke, getting downgraded to junk by Moody’s.  Methinks there could have been some official activity there to help support things.  Interestingly, both South Korea and Taiwan saw positive sessions, but most of the rest of the region did very little at all.  In Europe this morning, we are seeing gains led by the FTSE 100 (+1.0%) which seems to be responding to a slightly softer than forecast employment report (Unemployment rose to 3.9% and wages slid a bit) with growing expectations that a rate cut will come sooner rather than later.  And at this hour (7:30) US futures are a bit firmer, about 0.3% or so.

In the bond market, yields backed up slightly yesterday although the 10-year Treasury remains at 4.10% ahead of both the CPI report and today’s 10-year auction.  European yields are a touch softer this morning -1bp, except for UK Gilts (-6bps) which also see the prospects for a rate cut coming sooner than previously thought.  Finally, JGB yields edged 1bp higher overnight amid further chatter that the BOJ is going to move next week.  The latest rumors from Tokyo are that the Shunto wage talks have seen significant wage hikes agreed which has been a precondition for the BOJ to exit NIRP.  It strikes me that whether they move on Monday or next month it doesn’t really change anything as I continue to believe that the totality of the movement will be limited at best, perhaps 30bps overall.

In the commodities markets, oil is little changed this morning, still stuck in the middle of its recent trading range.  Gold (-0.4%) is sliding this morning for the first time in 2 weeks, in what appears to be a modest correction.  However, both copper and aluminum are a bit firmer this morning along with most of the rest of the commodities space as the dollar seems to be drifting a bit.

Speaking of the dollar, I would argue it is a touch softer overall, although there are both gainers and losers around.  ZAR (+0.6%) and SEK (+0.4%) are the best performers across all currencies while we are seeing weakness in JPY (-0.3%) and HUF (-0.4%).  The gainers appear to be a product of inflows to their equity markets as both have had good runs today while the laggards have no such excuse with Hungarian stocks rising nicely.  As to the yen, that remains beholden to the BOJ story I believe, so is likely to remain somewhat idiosyncratic compared to the rest of the FX complex until next week.

And that’s really all we have today.  It’s CPI then bust.  I remain in the sticky inflation camp and anticipate a print at least at the current expectations with a decent chance of something a touch higher.  I remain convinced that the next dot plot will show only 2 rate cuts as the median forecast for the Fed and today’s data will be a key part of that story.  If that is the case, the dollar’s recent weakness is likely to come to an end as it finds some real support.

Good luck

Adf

If Doves Seduced

Posted on by 
The British inflation release
Showed prices did not quite increase
As much as expected
Though still they’re projected
To stay at a level, obese

But truly, all eyes have now turned
To Jay, when past two, we’ll have learned
If hawks rule the roost
Or if doves seduced
The Chairman with more rate hikes spurned

As New York walks into the office this morning, all thoughts are on how the FOMC meeting will play out.  The current expectation is for no rate movement today and still about a 50% chance of one more hike either in November or December.  More remarkably, as I wrote yesterday, is the belief that there will be 100 basis points of cuts next year despite the growing belief of either a soft landing or no landing.  Again, I ask, why would the Fed cut rates if the economy continues to grow with the current monetary policy?  However, at this point, all we can do is wait.

FWIW, which may not be much, I continue to see the outcome as follows; no movement today, 25bps in November and then a reassessment in December based on how the data continues to flow.  Nothing Powell has said indicates that he is comfortable that the Fed has vanquished inflation, and similar to the idea that every politician only cares about one thing, his reelection, I believe Powell is completely focused on just one thing, killing inflation.  He has made it abundantly clear in the past that he expected some economic pain would be necessary in order to achieve that outcome, and he is not going to be deterred at this stage.  It would not surprise me if Fed funds remained at the year-end 2023 rate, whether that is 5.50% of 5.75%, for all of 2024.  In fact, absent a very significant recession, that is what I believe will occur.  One man’s view.

Anyway, turning to the only other data of note today, UK CPI surprisingly fell to 6.7%, down from last month’s 6.8% reading and forecasts for a 7.0% outcome today based on rising energy and food prices.  Even better for Governor Bailey, the core rate fell to 6.2%, well below last month’s level of 6.9% and forecasts of 6.8%.  The pound dipped on the news, but only by -0.2%, as the entire FX complex remains in thrall to the FOMC outcome later this afternoon.  However, this inflation result has pundits asking whether Governor Bailey will be able to skip tomorrow’s rate hike, just like the Fed, and wait until November if they deem it still necessary.  My view here is that will not be the case.  Given the overall weakness in the UK economy, Bailey is clearly running out of room to hike rates, and tomorrow is likely to be his last chance to raise rates before the evidence of sustained weakness becomes clear.  Just like the rest of Europe, I expect the BOE will hike tomorrow and be done.

Once again, I will point out that the basis of my dollar views remains that the US is going to be the most hawkish of all the major economies, maintaining tighter monetary policy far longer than other nations, and that the dollar will naturally see investment flows continue.  After all, the combination of higher yields and potentially better growth prospects will be far too much for international investors to ignore.

For now, though, we wait for 2:00pm and the FOMC statement along with their new Summary of Economic Projections, and then for Chairman Powell’s presser at 2:30.  As such, until then I expect a pretty dull day.

Overnight, Asian equity markets were under pressure with losses in both Japanese and Chinese shares, as well as generally throughout the region.  The only noteworthy news was that the PBOC left rates on hold, which was widely expected, although there were those who thought they might cut again to support the weakening Chinese economy.  European bourses, though, are having a much better day, with all markets higher by at least 0.5% and several southern European nations seeing gains greater than 1%.  Meanwhile, at this hour (7:30), US futures are edging higher by 0.2% or so after modest declines yesterday.

In the bond market, yesterday’s closing level for 10yr Treasuries was the highest, at 4.36%, since October 2007, and although the yield is lower today by about 2bps, this trend remains intact.  The big mover today, though, is UK Gilts which have seen yields drop 8bps after that CPI report.  This has helped drag European sovereign yields lower by about 2bps as traders want to believe that the rate hikes are over everywhere in Europe, and cuts are the next step.  While that’s not my view, it is gaining traction.

In the commodity markets, oil (-1.0%) has finally had a pullback of substance after a rumor yesterday that the Biden administration was going to completely empty the SPR.  There has been no source for that story and no corroboration but given the move that oil has seen over the past 3 months, up more than 35%, a pullback is no surprise.  While there is likely to be a further short-term retreat here, the long-term prospects for oil remain significantly positive in my view.  As to the metals markets, industrials are a bit firmer this morning, perhaps on the idea that the rate hiking cycle in Europe is ending, while gold is unchanged.

Finally, the dollar is a bit softer this morning, but not very much.  The euro remains either side of 1.07 while USDJPY is pushing the 148 level, very close to the key 150 point where many participants believe the BOJ will step back into the market.  As to CNY, its home has been the 7.30 level despite all the effort that the PBOC has expended to strengthen the yuan.  The biggest winners today have been the Antipodeans, with both AUD and NZD firmer by 0.5% after the Minutes of the RBA meeting indicated that they were considering another rate hike at the last meeting although decided to hold off.  The implication is another hike could be in the cards.

On the data front, really the FOMC meeting is today’s only activity of note, although we will see the EIA oil inventories as well.  Until the meeting ends, I expect very little to occur.  Once the announcement is out, and even more importantly, once Powell starts to speak, be prepared for more volatility.

Good luck

Adf

Growth Will, Fall, Free

Posted on by 
In China when data is weak
And nothing implies there’s a peak
The answer is to
Remove it from view
And henceforth, no more of it speak

But just because President Xi
Decided there’s nothing to see
That will not prevent
The wid’ning extent
Of views China’s growth will, fall, free

Last night China released their monthly series of economic statistics, all of which were lousy.  Briefly, Retail Sales (2.5%), IP (3.7%), Fixed Asset Investment (3.4%), Property Investment (-8.5%) and Unemployment (5.3%) all missed the mark with respect to economists’ forecasts and all indicated much weaker growth than previously expected.  Conspicuously there was one data point that was missing, youth unemployment, which had been rising rapidly over the past months and in June reached a record high of 21.3%.  However, given the amount of negative press coverage that particular data point was receiving, especially in the West, it seems that President Xi decided it was no longer relevant and it will not be published going forward.  Given the broad-based weakness in all the other data, as well as the fact that there are many new graduates who would have just entered the workforce, one can only assume the number was pretty substantially higher than 21.3%.

The other news from China was that the PBOC cut their 1yr Medium-Term Lending Facility rate by 15bps in a complete surprise to the market.  As well, the 1wk repo rate was also cut by 10bps as the government there tries to address the very evident weakening economic picture without blanket fiscal stimulus.  One cannot be surprised that the renminbi weakened further, falling another -0.4% onshore with the offshore version currently -0.5% on the session.  One also cannot be surprised that Chinese equity markets were all under pressure as prospects for near-term growth continue to erode.  FYI, the renminbi is within pips of its weakest point in more than 15 years and, quite frankly, there is no indication it is going to stop sliding anytime soon.  I continue to look for 7.50 before things really slow down.

As growth increases
And inflation remains high
Can QE remain?

In contrast to the Chinese economic data, we also saw Japanese data overnight and it was a completely different story.  Q2 GDP was estimated at 6.0% on an annual basis, much higher than expected and an indication that Japan is finally benefitting from its policy stance.  While inflation data will not be released until Thursday, the current forecasts are for little change from last month’s readings.  However, remember every inflation indicator in Japan is above the BOJ’s 2% target so the question remains at what point is QE going to end?  For the FX market this matters a great deal as USDJPY is back above 145 again, and if you recall the activities last October, when USDJPY spiked above 150 briefly and the BOJ/MOF felt forced to respond with significant intervention, we could be headed for some more fireworks.  However, despite the BOJ’s YCC policy adjustment at the last BOJ meeting in July, the JGB market has remained fairly well-behaved, so it doesn’t appear there is great internal pressure to do anything yet.  The flipside of that is the US treasury market, where 10yr yields are back above 4.20% and that spread to JGBs keeps widening.  As the Bloomberg chart below demonstrates, the relationship between 10yr Treasury yields and USDJPY remains pretty tight.  Given there is no indication 10yr yields are peaking, I suspect USDJPY has further to rise.

All this, and we haven’t even touched on Europe or the UK, where UK employment data showed higher wages and a higher Unemployment Rate, a somewhat incongruous outcome.  The Gilt market has sold off on the news, with yields climbing about 6bps, but the rest of the European sovereign market is much worse off, with yields rising between 8bps and 12bps.  Treasuries are the veritable winner with yields this morning only higher by 3.5bps.

What about equities, you may ask, after yesterday’s positive US performance.  The disconnect between the NASDAQ’s ongoing strength in the face of rising US yields remains confusing to many, this poet included, as the NASDAQ, with all its tech led growth names, seems to be an extremely long duration asset.  But, another 1% rally was seen yesterday, ostensibly on the strength of Nvidia which rallied after a number of analysts raised their price target on the company amid news that Saudi Arabia and the UAE both have been buying up the fastest processors the company makes.  Well, while Japanese equities managed gains after the strong data, all of Europe is in the red, all by more than 1% and US futures are currently (7:30) lower by about -0.5%.  If US yields continue to rise, and there is no indication they are going to stop doing so in the near future, I find it harder and harder to see equity prices continue to rise as well.  Something’s gotta give.

Interestingly, the commodity space seems to be out of step with the securities markets.  Or perhaps not.  Oil (-1.0%) is down for the third day in four, hardly the sign of economic strength, as arguably the combination of rising interest rates and slowing growth in China would seem to weigh on demand.  And yet, the soft-landing narrative remains the highest conviction case among so many analysts.  So, which is it?  Soft landing with continued growth and energy demand?  Or a hard landing with energy demand falling sharply?  My money is on a harder landing, although I think energy demand will surprise on the high side regardless.  Meanwhile, both base and precious metals are under pressure today with copper (-1.6%) the laggard of the group.  Remarkably, despite ongoing USD strength, gold is still above $1900/oz, but at this point, just barely.

Speaking of the dollar, today is a perfect indication of why the dollar index (DXY) is not a very good estimator of the overall trend.  As I type, DXY is lower by about -0.2%, yet the dollar has risen against virtually every APAC currency and the entire commodity bloc in the G10.  In fact, the only currencies rising today are the euro and pound, both higher by about 0.2%.  At any rate, there is no indication that the dollar’s rebound is ending either.  This is especially true for as long as US yields continue to climb.  Think of it this way, global investors need to buy dollars in order to buy the high yielding Treasuries we now have, so demand is likely to remain robust for now.  

On the data front, Retail Sales (exp 0.4%, 0.4% ex autos) is the big number but we also see Empire Manufacturing (-1.0) and the Import and Export Price Indices.  In addition, we hear from Minneapolis Fed President Kashkari at 11:00, which is likely to have taken on more importance now that we have seen the first split on the concept of higher for longer.  Which camp will he fall into and how vocal will he be regarding the potential to cut rates next year?

But, putting it all together right now, risk is under pressure, and I see no reason for that to change today.  I guess a blowout Retail Sales number, something like 1.0% could get the bulls juices flowing, but that would likely push yields even higher and that is going to be a drag.  Either way, I like the dollar to continue to perform well here overall, especially against EMG currencies.

Good luck

Adf

A Bad Dream

Posted on by 
The narrative’s gaining more steam
With landings, so soft, the new theme
In England today
They’re trying to say
Inflation was just a bad dream

The problem is that on the ground,
In Scotland and Wales and around,
Is incomes keep lagging
With purchases sagging
Which pressures the Great British pound

The biggest story of the morning has clearly been the UK inflation data which saw CPI fall back below 8.0% Y/Y for the first time in more than a year.  Granted, 7.9% is not that far below 8% and certainly still miles above the BOE target, but the decline was substantially more than had been expected by the analyst community as well as the market.  For instance, 10-year Gilt yields have tumbled -17.5bps and are now lower by 50bps since the peak two weeks’ ago and back to their lowest level since early June.  2-year Gilt yields have fallen even further, -25bps, so the market is really quite positive on this outcome.

It should be no surprise that UK equity markets have rallied as well, with the FTSE 100 the leading gainer in Europe, up 1.5%, nor should it be a surprise that the pound has fallen sharply, -1.0%, as traders re-evaluate the idea about just how much the BOE is going to raise rates going forward.  Prior to this release, the OIS market had been pricing in a terminal interest rate at 6.1%, implying at least 4 more rate hikes by the BOE.  But this morning, traders have removed one of those hikes from the curve and the excitement over further potential declines is palpable.

Now, the inflation news in Europe is not all rosy as the final release on the continent showed that core CPI turned out to be a tick higher at 5.5% in June, clearly an unwelcome result.  And remember, it was just yesterday that we heard from Klaas Knot implying that while a hike next week is a given, nothing is certain past that.  So, the question, currently, is will the ECB look through a revision to continue their more dovish stance?  I guess we’ll find out next week.  

But here’s an interesting tidbit regarding Europe, and something you need to consider when it comes to both investments and market outcomes there, electricity demand is falling there amid deindustrialization on the continent.  The IEA just issued their latest Electricity Market Report and the reading was not pleasant for Europe.  Consider that in the US, the combination of reshoring and the impact of the (ironically named) Inflation Reduction Act, as well as the CHIPS Act, has driven a marked increase in industrialization in the US.  Meanwhile, in Europe, the loss of their cheap energy from Russia combined with their climate goals has resulted in industry fleeing the continent.  For everyone who is long-term bearish the dollar, you better be far more bearish the euro given this new reality.  Remember, energy consumption is the mark of a growing and healthy economy.  When it is declining, absent extraordinary productivity/efficiency gains, it bodes ill.  If anything, the increasing reliance on less dense energy sources like wind and solar just reduces energy efficiency.  Be wary.

But, away from that news, things are a bit more confusing.  For instance, virtually all European bourses are higher this morning, albeit not as much as the FTSE 100, but in Asia, while the Nikkei (+1.25%) had a good session, Chinese equities were under pressure.  Yes, US markets yesterday continued their rally as earnings data has been able to beat the much-reduced estimates although futures this morning are essentially unchanged.  But arguably, we can describe the equity picture as risk-on.  

The same cannot be said for the bond market though, where yields have fallen everywhere, again, just not as much as in the UK.  Treasury yields are down another 2bps, and most European sovereigns are also seeing modest yield declines, not the typical risk-on behavior.  In fact, given the Eurozone CPI release, it would not have been surprising to see yields climb a bit.

As to the commodity space, oil is essentially unchanged on the day, but WTI is back above $75/bbl with Brent right at $80/bbl after several strong sessions.  There has definitely been a renewed focus on the bullish supply story in oil as opposed to the recession discussion of late.  At the same time, gold (-0.3%) which has rallied nicely during the past week, up nearly 2%, is holding the bulk of its gains.  Alas, the base metals continue to lag, with both copper and aluminum softer on the day.  Perhaps they didn’t get the bullish memo!

Finally, the dollar is quite robust this morning, which is not what one might expect given the equity and bond moves.  In fact, it is firmer vs. the entire G10, with the pound the laggard, as would be expected given the inflation data and falling UK rates.  But as well, the yen (-0.8%) is under pressure along with AUD (-0.7%) and the whole lot.  Regarding the yen, it has been rallying sharply of late, up more than 5% during July until yesterday.  That seems to be on an increasing belief that the BOJ, which meets next Friday, is going to tweak its policy in a tighter fashion, whether that involves YCC or rates or QE.  Now, these stories have not disappeared, I just think that we are seeing a bit of a breather for this move.  Remember, the yen has been the funding currency of choice for every asset all year as the BOJ remains the only central bank that hasn’t tightened policy at all.  This month appeared to be profit-taking ahead of potential BOJ activity, and last night appears to be a simple trading bounce.  FWIW, I do not believe the BOJ is ready to adjust its policy yet as the big review has just begun.  And as I have written before, it doesn’t appear that the rising inflation pressures in Japan have yet become a major political liability for PM Kishida, so there is only limited pressure to make a change.  For now, I would rather be short than long the yen.

Turning to the EMG bloc, only THB (+0.5%) is firmer this morning as the political machinations continue there in the wake of the recent election. In a nutshell, the winner of the election to replace the military junta is clearly not favored by the powers-that-be, and is being disqualified on a technicality, but another member of the coalition seems to be getting closer to taking the reins, with optimism building.  But aside from that story, the dollar is firmer vs. the entire bloc as we are seeing a solid trading bounce in the greenback after several days/weeks of weakness.

On the data front, yesterday’s Retail Sales data was disappointing, and the IP and Capacity Utilization data were awful.  Obviously, that didn’t hurt equities which remain disconnected from any macro data at this point.  This morning brings the Housing Starts (exp 1480K) and Building Permits (1500K) data, although if Retail Sales didn’t have an impact, it is hard to believe the housing data will.  

I remain uncomfortable with the equity market’s ongoing rally as I fail to see the underlying strength in the economy or earnings.  Certainly, recent dollar weakness has helped goose the stock market a bit, but I would not be surprised to see things start to turn around in the near term, meaning the dollar rebounding after its recent sell-off and the equity market seeing some profit-taking.

Good luck
Adf

4% is the New 2%

Posted on by 
The Kingdom that’s sort of United
Reported inflation’s ignited
And simply won’t fall
Regardless of all
The rate hikes that they’ve expedited

But of more importance today
Is hearing what Jay has to say
He’ll speak to the House
Whose members will grouse
Though their views will not hold much sway

Starting with the first big data point, CPI in the UK was higher than expected yet again, printing at 8.7%, unchanged from April’s reading and above the 8.4% consensus expectation.  Core CPI actually rose further, to 7.1%, a new high reading for the current bout of inflation and an indication that thus far, the BOE has not been very effective in fighting inflation.  The market response was mostly in line with what one would expect as the equity market sold off alongside Gilts as yields climbed further.  In fact, 2yr Gilt yields are now above 5.0% for the first time since 2008 and the UK yield curve is also steeply inverted, albeit not as steeply as the US curve.  As well, the OIS market is now pricing a one-third probability of a 50bp rate hike by the BOE when they meet tomorrow.  But weirdly, the pound is under pressure this morning.  It is the worst performing G10 currency (-0.4%) and unlike most recent market reactions, where higher interest rates lead to currency strength, it has a throwback feel to your old International Finance textbooks where higher inflation leads to currency weakness.

 

Arguably, the biggest problem that Governor Bailey has right now is that it doesn’t seem to matter what the BOE does, prices are continuing to rise.  My sense is that interest rate hikes may not be the right medicine for the UK’s current ailments (which could well be true in the US) as the genesis of this inflation is not excessive economic growth driving demand but rather fiscal policy profligacy driving demand.  If it is the latter, then higher interest rates may only exacerbate the inflation situation as the increased cost of debt service simply adds to the growing budget deficit which increases the amount of money available for people to spend.  Consider, if one owns 2yr Gilts yielding 5%, the amount of income available to that person/entity is far greater than when 2yr Gilts were yielding 1% two years ago and so there is more money to spend.  Just like in the US, the employment situation in the UK remains tight and wages are rising along with interest rates.  In other words, there is a lot more money floating around chasing goods, a pretty surefire recipe for increasing inflation.  Alas, this idea doesn’t fit well within the Keynesian dogma so I fear things will take a long time to recover in the UK.

 

Turning to the US, this morning we will hear from Chairman Powell for the first time since the FOMC meeting a week ago as he testifies before the House Financial Services Committee.  While it is always difficult to anticipate what types of questions people like Representative Maxine Waters (who thankfully no longer chairs this committee) will ask, I expect that there will be a lot of discussion regarding whether the Fed should continue tightening policy in the face of recent softer, albeit still high, inflation readings, and what is being done about issues like bank safety and oversight.  I am also quite confident that there will be questions/demands for the Fed to do something about climate change although Chairman Powell has already made clear it is not in their mandate.

 

However, ex ante, trying to assess what Powell is likely to say, I would estimate he will continue with the current Fed mantra of inflation remains far too high and that they are going to bring the rate of inflation back to their 2% target.  He is also likely to admit that doing so will cause pain via rising unemployment, something no Congressman/woman is going to want to hear.  But just like in the UK as explained above, it is entirely possible that the Fed’s reading of the current situation may not be accurate.  The playbook, as written by Paul Volcker, explains that the way to squash inflation is to raise interest rates high enough to cause a recession, kill demand and watch price increases end.  And that worked well in 1980-1982 as the US was dealing with both rising commodity prices as well as a demographic boom as Baby Boomers were entering the workforce along with women and there was a significant uptick in activity and productivity. 

 

The problem for Powell, who came of age during that period, is that is not very descriptive of today’s economy.  Instead, we have just come through a massive fiscal policy spend on the back of the pandemic response (similar to the end of a war) but the demographics are far less impactful as population is growing far more slowly and the working population is growing even slower.  Higher interest rates have increased the income for retirees and allowed them to increase demand as they spend that newfound money.  I’m not saying that cutting rates is the right path, just that raising them a lot more may not be very effective either.  Fiscal discipline would be a far more effective tool to fight inflation in the current environment I believe.  Alas, that is something that simply no longer exists.  As such, I fear that we are going to see inflation remain much higher than we had become used to for a much longer time.  I expect 4% is the new 2%.

 

At any rate, ahead of the Powell comments, which begin at 10:00am, this is what we’ve seen overnight.  Japanese equities continue to rock, rising again and now up nearly 29% YTD in yen terms.  The Nikkei has reached its highest level since December 1989, although has not yet passed the peak set in September of that year.  However, Chinese equities are on a completely different trajectory right now, with both the Hang Seng and mainland indices down on the year.  It seems investors are not enamored of President Xi’s economic leadership right now.  As to Europe, it is mostly softer, albeit not by much and US futures are similarly down slightly ahead of the opening.

 

Bond yields are edging higher outside of the UK with Treasuries back up 3bps and most of the continent up around 1bp.  Looking at Treasury activity lately, it has been choppy but not trending either higher or lower and sits in the middle of the 3.50% – 4.0% range that has defined trading since September.

 

Oil prices are little changed this morning and are also hanging about in a range lately as the market tries to determine the supply/demand function.  Is China growing enough to increase demand substantially?  How much oil is Iran getting into the market?  These are the questions that have no clear answers so visibility into trends is limited.  Meanwhile, gold got clobbered yesterday on dollar strength and the base metals had a similar response.

 

Finally, the dollar remains stronger rather than weaker overall, rallying yesterday against most of its counterparts and holding the bulk of those gains.  Today’s outlier is KRW (-0.9%) which suffered after the release of its export data showed a 12.5% decline of exports to China.  In truth, this bodes ill for both currencies, the won and the renminbi, which saw the offshore version trade through 7.20 last night for the first time in this move.  As I have written before, this has further to go.

 

There is no data today so basically, all eyes will be on the tape at 10:00 to hear what Powell has to say and how he responds to the questions.  For now, the market is losing conviction that another rate hike is coming, although there is no indication from Fed speakers that they have changed their view.  Next week, we will see the PCE data, and I suspect much will depend on how that prints before any new views can be expressed.  In the meantime, the dollar is caught between a sense of risk-off and a sense the Fed may be done.  Choppy is the name of the game.

 

Good luck

Adf