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Market Pulse: Skeptically Optimistic

The 10 year Treasury Note yield fell 13 basis points last week, a move that would not normally rate any mention whatsoever, but the path of that small…



The 10 year Treasury Note yield fell 13 basis points last week, a move that would not normally rate any mention whatsoever, but the path of that small decline does. From Monday to Thursday, the yield fell, from high to low, by 34 basis points, a move that added 1.3% to bond prices (Aggregate bond index) in four days. In a world where it takes a year to accumulate roughly 4% interest, that kind of move is significant. From Thursday’s low of 3.82%, the yield rose to 4.05% by Friday afternoon and closed at 4.03, a 21 basis point move in one day. The question is why? Why did we see such volatility in the bond market last week?

Well, there was an FOMC (Federal Reserve Open Market Committee) meeting last week and as I’ve pointed out numerous times in the past, the Fed’s policy of forward guidance has produced more, not less, volatility than in the past. The essential problem is that they create expectations regarding future policy based on their economic projections which have been almost comically wrong over the years. The Fed can’t predict the future any better than your local psychic, which wouldn’t be a problem if they had the same influence on the economy as the typical crystal ball gazer. But of course that isn’t the case. Or is it?

The focus for markets from the FOMC statement and Jerome Powell’s press conference was the future course of short term interest rates. Would the Fed be cutting rates this year and if so, when and by how much? Powell wasn’t expected to say a lot about that, other than the standard “we’re data dependent” response, but he surprised markets by essentially saying that a cut in March was not anticipated. As soon as he said that, the stock market started to sell off and by the close was down 1.2%. Interestingly, bond yields didn’t move all that much but what move there was, was down. That would seem to indicate the market believed that not cutting in March would be a mistake, one that would lead to economic slowdown. How exactly anyone thinks they can know that right now is beyond my reckoning but that’s the clear implication.

People sold stocks and bought bonds because the odds of a rate cut in March fell during the press conference. Are there really people who believe that leaving short term interest rates unchanged for the next few months will have a significant impact on economic growth? I mean we’re talking about a difference of 0.25% for four months (assuming the first cut comes in May instead). Is that really enough to change the course of the economy? Seriously?

During his press conference Powell said:

Our restrictive stance of monetary policy is putting downward pressure on economic activity and inflation.

Earlier in the speech he offered scant evidence of that downward pressure:

GDP growth in the fourth quarter of last year came in at 3.3 percent. For 2023 as a whole, GDP expanded at 3.1 percent, bolstered by strong consumer demand as well as improving supply conditions. Activity in the housing sector was subdued over the past year, largely reflecting high mortgage rates. High interest rates also appear to have been weighing on business fixed investment.

Housing has added to real GDP growth for two quarters in a row and fixed investment for four. It is true that housing was “sluggish” last year with higher mortgage rates but most of that was in existing home sales which don’t have a large impact on economic growth. New construction is where GDP is most impacted and on that front the Fed’s rate hikes didn’t accomplish much. Housing starts were up 7.6% over the last year, permits were up 6.1% and new home sales rose 4.4%. Ironically, if the Fed hadn’t raised rates so far, new construction and home sales may have been lower as there would have been more availability of existing homes with lower rates. As for fixed investment, I suppose it is possible that investment would have been higher with lower rates but the second biggest negative on the investment side last year was…inventories, which had nothing to do with Fed policy and everything to do with the supply chain hangover from COVID. Residential investment was the biggest negative in fixed investment but that essentially ended three quarters ago and was more than offset by non-residential. So, where exactly is the impact of the Fed’s higher short term interest rates?

If the Fed raised short term interest rates by 5.25% over roughly 18 months and had almost no impact on the economy, why would not lowering rates by 0.25% have any impact at all?

The Fed doesn’t know any more about the economy than the private sector. Jerome Powell makes that clear in the question and answer period. When asked what it would take for the Fed to have greater confidence that inflation is on a sustainable lower path he said:

So we have six months of good inflation data. The question really is: That six month of good inflation data, is it sending us a true signal that we are, in fact, on a path—a sustainable path down to 2 percent inflation? That’s the question. And the answer will come from some more data that’s also good data.

The Fed doesn’t know if inflation has peaked or whether this is just a lull before another wave higher. And neither does anyone else. They have the same information everyone else has. In answer to one question he mentioned that they consult a variety of Taylor rules in considering whether to move rates. Taylor rules are formulas for setting the Fed Funds rate, the original of which was developed by John Taylor at Stanford. Want to see what Powell’s looking at? Here you go: Atlanta Fed Taylor Rule Utility and Cleveland Fed Simple Monetary Rules. And it wasn’t exactly obscure before these were posted on various Fed website. Google it and you’ll get more information than you ever wanted. The Fed decision makers are looking at the same things we are and trying to figure out what’s going on. In fact, Jerome Powell is using the same language about the economy that I’ve been using for two years.

…the economy has, largely, reopened and is broadly normalizing, as you see.

I think the labor market by many measures is at or nearing normal, but not totally back to normal.

The economy is broadly normalizing

But we do expect that it will moderate as supply chain and labor market normalization runs its course…

…if you’re normalizing policy, you might be reducing rates but continuing to run off the balance sheet. In both cases, that’s normalization

I think we’re basically in the throes of getting through the pandemic economy

If you’ve been reading these weekly commentaries for any length of time, you know that’s been our theme almost since the onset of COVID, getting back to “normal”, in policy, in interest rates and in economic growth. And I’ve taken pains to point out that the yield on the 10 year Treasury note right now is right at the average since 1990 – this is normal, not the zero interest rate world of the post 2008 period. The question though is whether we will stay in this current zone of normality. I don’t know the answer to that but I laid out what to watch for in a video last October about Nominal GDP and interest rates. In that video I talked about what our future economic growth would look like based on what kind of productivity growth we get from our changed post-COVID economy. If we get productivity like we had in the period from 1990 to 2010, we’ll likely have NGDP growth of 5 to 5.5%. If we get productivity growth like we had in the 2010s, we’ll see NGDP growth of 4% and if you get a rerun of the 1980s, NGDP would grow upwards of 7%. With higher productivity comes higher nominal growth, higher real growth and lower inflation. Higher nominal growth without higher productivity growth yields less real growth and more inflation.

I don’t know what productivity growth will be in the future. That depends on investment and innovation that I can’t predict. Neither can Jerome Powell or anyone else at the Fed; they’re struggling with the same questions. Here’s Powell in the press conference:

I think we’re basically in the throes of getting through the pandemic economy. And the question will be, what is it that has changed? You know, productivity tends to be based on, you know, fundamental aspects of our economy.

Is there—is there a case—will it be the case that we come out of this more productive, more—on a sustained basis? And I don’t know. I don’t know. What would it take? It would take—you know, people talk about AI, but I would—my guess is that we may shake out and be back where we were because I don’t — I’m not sure I see—work from home doesn’t seem like it’s a big productivity increaser. AI—artificial intelligence, generative—may be, but probably not in the short run; probably maybe in the longer run. So I’m not—I’m not seeing why it would, but you know, right—you know, right now I would say that productivity is kind of what falls out of the broader forces that are driving people in and out of the labor force, and activity returning, and supply chains getting fixed.

If you’ve been sitting around waiting to hear the next utterance from Jay Powell or any other member of the Federal Reserve, you’re wasting your time. I’ll let you in on a little secret. While everyone in the investment business was glued to their TV listening to Jerome Powell’s every word, my TV was turned off and I was working on something unrelated to the economic outlook. I read the transcript the next day in the Wall Street Journal. I already knew what the FOMC would do and I knew mostly what Powell was likely to say. It was just common sense and I had more important things to do. I’m certain you do too. So, stop waiting with bated breath for the next statement from the FOMC and start thinking for yourself (or just keep reading these weekly commentaries).

There were any number of things that might have moved interest rates last week because traders respond to every new piece of information. Indeed, today, it seems they overreact to every new piece of information. But, as Albert Einstein said, information is not knowledge. Another announcement last week, the quarterly refunding announcement from the Treasury, was as anticipated as the FOMC statement and just about as important, which is to say, not very. In the QRA the Treasury provides information about how they will raise the necessary funds from the market to finance the government over the coming quarter. There are people who believe they can gain some kind of advantage from this information and that might be true if they got it before everyone else. Otherwise, any advantage is based on what? Reading speed? Besides, I told you last week to expect the Treasury to announce they would be selling a lot of TBills. And when I finally got around to reading the press release at the end of the week, that’s exactly what I found.

You aren’t going to gain any insight into the economy or markets by watching Jerome Powell’s press conference (or his interview on 60 minutes tonight) or reading every detail of the QRA. You gain insight by thinking for yourself, something that seems almost quaint today. Don’t wait for someone else to tell you what you should think, about markets or the economy or anything else. There are a range of possibilities that includes a lot that no one will see coming but we all have the same information. It is up to us to turn it into knowledge.

I don’t know what the future holds. I am, like Jerome Powell, looking at a range of things, from immigration and demographics to trade and industrial policy to AI to work from home to gene editing to MRNA technology and trying to figure out if any of it adds up to better economic growth and less inflation. I am very pessimistic about immigration and trade, where restrictions on both are likely to lead to less growth and higher inflation. I am encouraged by technological developments although I am skeptical that AI is the big answer everyone seems to think. Call me skeptically optimistic.

Joe Calhoun


The environment is…in flux. There’s almost no change in rates or the dollar over the last six months and for the dollar the last year. The 10 year yield is in a short term downtrend and barely hanging on to the uptrend that started in late 2021.

The dollar is in a short term downtrend but it isn’t of much significance; call it neutral if you want. The long term uptrend that started in 2011 remains intact.


Markets year to date are all about large cap growth stocks. All the other major asset classes we follow for our portfolios are down on the year. Thinking longer term, the three year numbers continue to favor value stocks, large and small. Real estate has given back some of late last year’s gains but that is not unusual after such a big run in a short period of time. Interestingly, last week when everyone was worried about regional banks – for the record I’m not – REITs were down a fraction of a percent.


The big sector winners last week were communication services, on the back of a huge gain in Meta, nee Facebook, consumer defensive (and healthcare which is generally defensive) and consumer cyclical. If you can find a theme there, please let me know.

Market/Economic Indicators

Some economic news from last week that was overlooked because everyone was focused on the Fed and the payroll report (which is subject to large revisions and means next to nothing on first release):

  1. S&P Case Shiller home prices were down 0.2% month to month in November (the data lags a lot). A moderation in home prices would be very positive for future inflation.
  2. Consumer Confidence rose from 108 in December to 114.8 in January
  3. The employment cost index rose less than expected, up 0.9% in Q4
  4. Non-farm productivity rose 3.2% in Q4 and unit labor costs rose just 0.5%
  5. S&P manufacturing PMI rose back to expansion in January at 50.7 versus 47.9 in December
  6. ISM manufacturing index rose to 49.1 in January versus 47.1 in December and expectations for a decline
  7. ISM manufacturing new orders rose to 52.5 in January versus 47 in December. That’s the first reading above 50 (indicating expansion) since August of 2022.
  8. Construction spending rose 0.9% in December
  9. University of Michigan consumer sentiment rose to 79 and inflation expectations fell under 3%.

Here’s some long term trends that are pretty encouraging:

Real (inflation adjusted) weekly earnings are rising at a healthy pace

Government employees as a percent of the total is lower than any time since the 1960s

Real disposable personal income is rising at a rate considerably higher than the average since 1990



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Industrial Production Decreased 0.1% in January

From the Fed: Industrial Production and Capacity Utilization
Industrial production edged down 0.1 percent in January after recording no change in December. In January, manufacturing output declined 0.5 percent and mining output fell 2.3 percent; winter…



From the Fed: Industrial Production and Capacity Utilization
Industrial production edged down 0.1 percent in January after recording no change in December. In January, manufacturing output declined 0.5 percent and mining output fell 2.3 percent; winter weather contributed to the declines in both sectors. The index for utilities jumped 6.0 percent, as demand for heating surged following a move from unusually mild temperatures in December to unusually cold temperatures in January. At 102.6 percent of its 2017 average, total industrial production in January was identical to its year-earlier level. Capacity utilization for the industrial sector moved down 0.2 percentage point in January to 78.5 percent, a rate that is 1.1 percentage points below its long-run (1972–2023) average.
emphasis added
Click on graph for larger image.

This graph shows Capacity Utilization. This series is up from the record low set in April 2020, and above the level in February 2020 (pre-pandemic).

Capacity utilization at 78.5% is 1.1% below the average from 1972 to 2022.  This was below consensus expectations.

Note: y-axis doesn't start at zero to better show the change.

Industrial Production The second graph shows industrial production since 1967.

Industrial production decreased to 102.6. This is above the pre-pandemic level.

Industrial production was below consensus expectations.

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Week Ahead: Will Soft US CPI and Retail Sales Mark the End of the Interest Rate Adjustment and Help Cap the Greenback?

markets are still correcting from the overshoot on rates and the dollar that
took place in late 2023. The first Fed rate cut has been pushed out of…



The markets are still correcting from the overshoot on rates and the dollar that took place in late 2023. The first Fed rate cut has been pushed out of March and odds of a May move have been pared to the lowest since last November. The extent of this year's cuts has been chopped to about 4.5 quarter-point move (~112 bp) from more than six a month ago. The market has reduced the extent of ECB cuts to about 114 bp (from 160 bp at the end of January and 190 in late 2023). The Bank of England is now expected to cut rates three times this year (75 bp), which is nearly 100 bp less than was discounted at the end of last year. The extent of Bank of Canada rate cuts this year has been halved to less than 80 bp from 160 bp in late December 2023. We suspect that the interest rate adjustment is nearly over. A soft US CPI and weak retail sales report next Tuesday and Wednesday could help cap US rates and signal the end of the dollar's New Year rally. 

The UK reports CPI on February 14, and given the base effect (-0.6% in January 2023), even a 0.3% decline in prices last month, the year-over-year rate is likely to rise (to 4.2%-4.3%). However, the bigger story for the UK, the eurozone, and Canada is that inflation rose sharply in the Feb-May period last year, and as these drop out of the 12-month comparisons, the year-over-year rates will fall dramatically. The UK and Japan will report Q4 23 GDP. The UK economy likely contracted slightly for the second consecutive quarter. Japan, the world's third-largest economy, likely returned to growth after contracting at an annual rate of almost 3% in Q3. Consumer spending and capex fell in Q2 and Q3 24. Both likely recovered. The UK and Australia report new labor market figures. In the UK wages are moderating and the economy likely lost full-time positions for the second consecutive month in January. It is difficult to image a worse employment data than Australia reported last month. It lost 106k full-time jobs, which, outside of the pandemic, looks like the worst on record. 

United States:  The data and official guidance have pushed out expectation of the first Fed cut and reduce the extent to this year's cut. The market's confidence (~73%, down from 90% after the employment data) of a May move still seems too high given the apparent momentum the economy enjoys in early 2024, even if we do put too much emphasis on the Atlanta Fed's GDP tracker (3.4%) this early in the quarter. The market has about 4.5 Fed cuts discounted this year, down from more than six cuts as recently as mid-January. The May decision is unlikely to be determined by January data. That counts even this week's highlights of CPI, retail sales, and industrial production.

At his post-FOMC press conference, Fed Chair Powell called attention to "six months of good inflation." This looks to have continued into this year. The headline CPI rate is seen rising by 0.2% (February 13), which, given the base effect (0.5% in January 2023), would see the year-over-year rate fall to 3.0%-3.1% from 3.4%  Yet, the median forecast from the nine economists that participated in Bloomberg's survey (by end of last week) see it falling to 2.9%. The core rate is expected to rise by 0.3% for the third consecutive month and the fifth time in six months. That may be more important that the softer year-over-year rate (~3.7% vs 3.9%). 

January retail sales (Feb 15) may have been dragged down by disappointing auto sales (15 mln SAAR, down from 15.83 mln in December). Consumption would appear be off to a slow start after retail sales rose by an average of 0.2% in Q4 23 after a blistering 0.7% average gain in Q3 23. The median forecast is for a 0.2% decline in headline retail sales (+0.6% in December). On the other hand, industrial production (Feb 15) appears to have accelerated and the 0.3% increase the median in Bloomberg's survey is looking for would be the strongest in six months. However, manufacturing itself may be flat. Other high frequency data points include producer prices (year-over-year rates are below 2%), housing starts and permits (small gains expected), and a number of early regional Fed surveys. Of note, the Empire State Manufacturing Survey crashed in January (-43.7 from -14.5) and a sharp snap back is expected in February. On balance, the data is likely to be consistent with the US economy expanding somewhat faster than what the Federal Reserve believes is the long-term non-inflation pace (1.8%). 

The big outside day for the Dollar Index after the US employment data on February 2 saw follow-through buying at the start of last week. It reached 104.60, the highest level since the middle of last November and spent the rest of the week consolidating above 103.95. A move above the 104.80 is needed to reignite the upward momentum. Despite the stretched momentum indicators and the proximity of the upper Bollinger Band (~104.50), there is little technical sign of a top. That said, given the nearly 4% rally off the late December lows, this is the area where we are beginning to look for a reversal pattern.

Eurozone:  Details for Q4 23 GDP (flat and 0.1% year-over-year) will be released with the revisions on February 14. It may be interesting for economists, but the general thrust is sufficiently known for businesses and market participants. The eurozone economy is stagnating or worse. In the last five quarters through Q4 23, in aggregate, there has been no growth. Still, the details of fourth quarter GDP saps much interest in high frequency data from the end of last year. More importantly is the momentum at the start of the new year and the data so far have been limited to some surveys and a preliminary estimate of January CPI (-0.4% month-over-month and minus 3.2% at an annualized rate in the last three months). There seems to be little reason to expect new growth impulses, leaving this quarter to be flat to +0.1%.

The euro's low for the year was set at the start of last week slightly below $1.0725. The subsequent recovery stalled in the $1.0790-95 area, meeting the (38.2%) retracement objective from the Feb 2 high set shortly before the US January jobs report. The momentum indicators remain stretched, as one would expect, given the five weeks of losses in the first six weeks of the year. And if there is a more of a recovery, the $1.0810-40 area may offer stiff resistance. The 20-day moving average, which the euro has not closed above since January 2 is found at the upper end of that band. Note that there are options for 2.5 bln euro at $1.0725 that expire Monday and options for 1.5 bln euros at $1.07 expire shortly after the US CPI report on February 13.  There is another 1.4 bln euro s at $1.07 that expire Wednesday. 

Japan:  In each of the past six years, the Japanese economy contracted in at least one quarter (in 2018 and 2022 there were two contracting quarters). Last year, it was the third quarter, when output fell by 0.7% (quarter-over-quarter). A stabilization in consumption and a recovery in private investment, both of which fell in Q2 23 and Q3 23, likely helped return the world's third largest economy to growth. Exports also increased. The GDP deflator appears to have peaked in Q3 23 at a 5.3% year-over-year pace. On the back of firmer US Treasury yields and comments by BOJ officials that downplayed the likelihood of a tightening cycle even after negative interest rate policy is jettisoned, the dollar rose to nearly three-month highs against the yen (~JPY149.60). Although Japanese officials have not expressed concern about the price action in the foreign exchange market, the yen's six-week drop is the kind of one-way market that is resisted. The November high was near JPY149.75, in front of the psychologically important JPY150 level. There are $1.4 bln in options at JPY150 that expire shortly after the US CPI report on February 13. A move above JPY150 brings last year's high near JPY152 into view.

United Kingdom: It is an important week for UK data and the jobs report and the CPI, in particular will likely impact expectations for interest rate policy. Average weekly earnings have slowed for four consecutive months through November and look poised to continue to slow as the labor market cools. The key message on UK CPI is that it will fall sharply starting the February report and running through May. In those four months in 2023, UK CPI rose by an average of 1.0% a month. In the last four months, through January, the UK's CPI rose by an average of 0.2% a month. Due to 0.6% decline in January 2023 UK CPI, the 0.3% decline expected for last month's CPI will translate into a small increase in the year-over-year rate. But that is not the signal. Even if UK's inflation averaged 0.4% in the Feb-May period this year, the headline year-over-year rate would still slip below 2% (from 4% in December). The core rate is firmer, but the direction is lower. It peaked at 7.1% last May and finished the year at 5.1%. The UK also reports Q4 23 GDP. Recall that the monthly print showed a 0.3% contraction in October followed by 0.3% growth in November. It is seen contracting by 0.2% in December. That would likely translate to a 0.1% contraction quarter-over-quarter for the second consecutive quarter. Surveys suggest manufacturing remains weak while the services are finding traction. The swaps market has about a 70% chance that the first cut is delivered by midyear. Three cuts and about a small chance of a fourth cut is discounted for this year. 

Sterling broke out of its $1.26-$1.28 trading range to the downside at the start of last week, largely on follow-through selling after the US jobs report on February 2. It bottomed near $1.2520 and recovered to settle above $1.26 for the past three sessions. Sterling's recovery stalled near $1.2645, the (50%) retracement of the losses from February 2 high (~$1.2770). The next retracement (61.8%) is around $1.2675, which is also where the 20-day moving average is found.

Australia: The January employment data will be reported early on February 15. It is difficult to imagine a worse report than December's, even though the unemployment rate held at 3.9% (up from 3.5% at midyear). Australia lost a stunning 106.6k full-time posts, which wiped out half of the increase reported in the Jan-November period (~211k). Part of the reason that the unemployment rate did not rise was that the participation rate fell by a sharp 0.5% to 66.8%. At the same time, other hard data have been poor. Remember December retail sales tumbled 2.7% in the face of expectations of a 0.5% gain. November gain itself was revised lower by nearly as much as economists had forecast a December gain (1.6% vs. 2.0%). Building approvals dropped 9.5%. Here, too, economists (median in Bloomberg's survey) forecast a 0.5% increase. November's 1.6% gain was revised to 0.3%. There may be scope for the market to bring forward the first rate cut by Reserve Bank of Australia to June from August. 

The Australian dollar recorded a new low for the year last Monday near $0.6470, its lowest level since mid-November as it extended the post-US jobs data drop. However, it stabilized and largely traded in a range mostly between $0.6480 and about $0.6540. The upper end of the range corresponds to the (50%) retracement of the decline from the pre-jobs data high a little above $0.6600. The next retracement (61.8%) is near $0.6555, and the 20-day moving average, which the Aussie has not closed above since January 3 is a little higher (~$0.6560).

Canada:  Canada has a light economic diary in the coming days. January existing home sales and housing starts, and Canada' portfolio investment account (December) rarely moves the market in the best of times. In terms of drivers, the 30- and 60-day correlations with the changes in the exchange rate seem to be the general direction of the dollar (DXY) and risk-appetites (S&P 500). The Canadian dollar seems less sensitive to oil and two-year rate differentials (less than 0.2 correlation for both period). The US dollar took out the January high marginally and rose to about CAD1.3545 early last week before consolidating at lower levels ahead of the Canadian employment data reported before the weekend. The Canadian dollar strengthened initially on the news, even though full-time jobs fell for the second consecutive month. The greenback found support ahead of CAD1.3400 and recovered back to set new session highs near CAD1.3480. The risk seems to be on the upside. 

Mexico:  After the January CPI figures and the central bank decision to hold policy steady, there may not be market-moving economic data February 22 with another look at Q4 23 GDP (0.1%), first half of February CPI, and minutes from the Banxico meeting. The central bank raised quarterly inflation forecasts through Q3 but left the Q4 24 projection at 3.5%. The target is 3%, +/- 1%. The dollar initially moved higher in response, but the upticks (to ~MXN17.17) were short-lived. The greenback settled last week below MXN17.10, to post its second consecutive weekly decline. The MXN17.00 area had been approached before Mexico's CPI and central bank meeting. It has not traded below there since January 16, but it could if the US CPI and retail sales data are soft and cap US rates. 



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The Greenback is in Narrow Ranges to Start the Week

Overview: The foreign exchange market is quiet. The
Lunar New Year holiday shut most Asian markets. That, coupled with the light
news in Europe, have…



Overview: The foreign exchange market is quiet. The Lunar New Year holiday shut most Asian markets. That, coupled with the light news in Europe, have served to keep the dollar in narrow ranges against the G10 currencies. The Swedish krona, Norwegian krone, and Japanese yen are posting minor gains against the greenback. The New Zealand dollar, which was strongest major currency last week (1.4%) is off by almost 0.5% today, making it the weakest today. RBNZ Governor Orr underscored the recent message that inflation is still too high (~4.7%). Emerging market currencies are narrowly mixed (+/-0.2%). Of note, India reports December industrial production and January CPI shortly.

The few equity markets in the Asia Pacific region that were not on holiday today, including Australia, India, and New Zealand slipped. Political uncertainty in Pakistan saw its stock market tagged for 3%. On the other hand, Europe's Stoxx 600 is trying to snap a three-day fall (less than 0.4%). Of note, real estate is the strongest sector today, rising by more than 1%. US index futures are trading firmly after new record-highs before the weekend. Benchmark 10-year bond yields are 3-6 bp lower in Europe. The 10-year US Treasury yield is off a basis point to around 4.16%. Gold is trading with a softer bias near $2020. Last week's low was around $2015. April WTI set this month's high before the weekend near $77.15. It is approaching the pre-weekend lows slightly below $76. Support is seen closer to $75. 

Asia Pacific

The top two BOJ officials played down speculation that the central bank’s from negative interest rates will signal the start of a tightening cycle, and for good reason. First, inflation is already well off its peak and could easily fall below the 2% target before the April BOJ meeting that is widely expected to adjust policy. Second, despite a shortage of workers, (Japan's working age population peaked nearly 30 years ago) and the gradual opening to foreign workers, wage growth continues to lag inflation. Third, and related, domestic demand is soft. Toward the end of the week, Japan will publish its initial estimate of Q4 GDP. Consumption is likely to have recovered weakly from the contraction in Q2 and Q3 23. In the five years (20 quarters) before the pandemic, Japan's private consumption component in its GDP contracted by an average of 0.2% a quarter. Also, note that although the BOJ set the overnight target rate at minus 0.10%, the effective rate at the end of last week was 0.005%. Governor Ueda is determined to exit the negative interest rate policy for technical and strategic reasons. Arguably, there was windows of opportunity previously, where the macroeconomic setting was conducive to exiting the negative policy rate. 

Most Asian markets were closed today, and China's mainland markets are closed all week for the Lunar New Year holiday. We expect that after the holiday, more efforts to support the economy and fight deflation will be forthcoming. Despite the stimulus in H2 23, the economy does not seem responsive. The assumption that the state-owned banks are just arms of the government is challenged by the same banks not fully passing on the PBOC's lower rates. The one- and five-year loan prime rates will be set on Feb 20. The same state-owned banks have also been reluctant to lend to the property market and enact the support measures Beijing unveiled in 2022. Lastly, consider the offshore yuan. It does not have to but with few exceptions respects the onshore band (2% for the dollar around the reference rate). Why? While the PBOC could intervene there, but when it does it is fairly clear. The last reference rate creates a band of ~CNH6.9640-CNH7.2485. Is it too much to suggest that the same mechanism that keeps the offshore yuan within the onshore band explains a great deal of how the PBOC manages the exchange rate? To paraphrase an old Chinese saying, "kill an occasional chicken to scare the monkeys."  

The dollar edged a little closer to the JPY150 level ahead of the weekend (~JPY149.60) before settling virtually unchanged near JPY149.30. There are around $1.4 bln in options at JPY150 that expire tomorrow. During the six-week decline in the yen, speculators in the futures market have grown their net short yen position by more than 50% to 84k contracts (~$7 bln). The greenback is a narrow range of about a third of a yen above JPY149. The price action looks like a bullish pennant or flag, The Australian dollar's range last week, roughly $0.6470-$0.6540, is the key to the near-term direction. We favor an upside break and watching the possible bullish divergence with some of the momentum indicators but recognize the $0.6555-75 area to be an important hurdle. The Aussie eked out a small gain last week (~0.20%), the first of the year. Speculators in the futures markets added to their net short Australian dollar position for the fourth week in a row. It now stands at about 71.8k contracts (~$7.2 bln), up from 32.3k before the streak began. The Aussie is trading in about a fifth of a cent range above $0.6510.


The European economic calendar is light this week, and what there is, may be a sad reminder of the Europe's sad state. Eurostat will publish the details of Q4 23 GDP. The initial estimate had the regional economy stagnating after a 0.1% contraction in Q3. The dramatic 1.6% drop in Germany December industrial output (-3.0% year-over-year) underscores the lack of growth impulses to start the new year, and the weakness of what had been the European engine. At the same time, leadership is weak. Among the large members, Italy's Meloni, right-government seems among the strongest, and incidentally, the economy is doing better (but still not well). In 2022, Germany grew by 1.8%. Italy grew twice as fast. Last year, the German economy contracted by 0.3%, while Italy expanded by 0.7%. On the other hand, Italy's budget deficit was about 5.4% of GDP last year, while Germany's was less than 2.5%. Italy's 10-year premium over German narrowed to about 140 bp at the end of January, almost a two-year low, after rising to a nine-month peak last October over 200 bp. It is snapping back this month is near 155 bp. Italy's two-year premium peaked near 95 bp in the middle of last October and fell to almost 45 bp late last month. Last year's low was below 30 bp. It has jumped to about 65 bp now, the most since last November.

The Swiss franc was the strongest G10 currency in Q4 23 as dollar fell across the board. It rose 8.8% and so far, this year, the franc has fallen by about 3.9%. The dollar approached the (50%) retracement objective (~CHF0.8790). Above there is the 200-day moving average (~CHF0.8845) and the (61.8%) retracement near CHF0.8900. The euro is recovering from multiyear lows set against the franc in Q4 23 (~CHF0.9255). It traded up to almost CHF0.9475 last month but pulled back to support near CHF0.9300 earlier this month. There may be potential toward CHF0.9500-CHF0.9550. Switzerland reports January CPI tomorrow. The EU harmonized measure is expected to slip to 2.0% from 2.1%. Its own measure is seen easing to 1.6% (from 1.7%) and the core rate to 1.4% (from 1.5%).

The euro reached a six-day high late in thin Asia Pacific turnover near $1.0805. It was quickly sold to almost $1.0765 before finding a bid in early European turnover. It is the fourth session of higher highs. The pre-weekend low was almost $1.0760, and a break of the $1.0755 area would weaken the fragile technical tone. There are options for about $755 mln euros at $1.08 that expire today. There are large (1.4-1.5 bln euros) at $1.07 that expire tomorrow and Wednesday. Stiff resistance is seen in the $1.0830-40 area. Sterling recovered after breaking down at the start of last week (~$1.2520) but settled back into the $1.26-$1.28 trading range in the past three sessions. The $1.2640 area had capped but, like the euro, set a new six-day high before Europe opened and took sterling down to almost $1.2615. Before the weekend, sterling briefly frayed the $1.26 level. It is an important week for UK data, including the labor market report tomorrow and the January CPI on Wednesday. Soft data may encourage bringing forward the first rate cut to June from August. 


Interest rates and expectations are a key force driving exchange rates. The market has gradually reduced the odds May rate cut to about 73% from 90% chance after the strong January jobs growth. It also scaled back the magnitude of Fed cuts by about 50 bp (to ~112 bp) in the past month. Tomorrow's CPI, more than last week's historic revisions, is a key input into the Fed's reaction function. Fed Chair Powell recently indicated the central bank was looking for more confirmation that inflation was on a sustained path back to its target. The January figures will give the Fed that. Ahead of it, the results of the NY Fed's inflation survey are of little consequence.

Canada reported a loss of full-time jobs in January for the second consecutive month. Wage growth slowed. The decline in the unemployment rate to 5.7% (from 5.8%) can be explained by the decline in the participation rate (65.3% vs. 65.4%). The takeaway is that the market boosted the chances of a June rate cut (to ~77% vs. ~67%). Despite the risk-on mood, which lifted the S&P 500 to a new record high, the Canadian dollar found no traction. It fell slightly for the first time in three sessions. The US dollar made session highs near midday in NY ahead of the weekend near CAD1.3480. The greenback is in a narrow 20-tick range above CAD1.3450 so fat today. Nearby resistance is seen in the CAD1.3500 area but the greenback has been turned back from the CAD1.3540 area three times. There are options for about $630 mln at CAD1.35 that expire tomorrow. The Mexican peso weakened after the central bank seemed to prepare the market for a rate cut as early as next month. However, it recovered and returned to pre-central bank levels near MXN17.08. It has edged low today to MXN17.0640. MXN17.00 was tested early last week. Around $580 mln of options expire there on Thursday. The US dollar reached BRL5.0175 at the start of last week. On the pullback, it found support near BRL4.95. It settled last week just above there. There is a band of technical support between BRL4.91 and BRL4.93.



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