Good morning … We’re beginning the week with some news outta China which seems to be summarily dismissed ….
Reuters: China's Country Garden seeks to delay onshore bond repayment, fanning market fears
… And this news would have, in years past, given markets a jolt overnight. Typically stocks would be down and bonds would be BID but this is NOT the case and so … nothing to see here, folks … simply move along and stick WITH the soft / NO landing calls combined with “RATE CUTS” — more from Goldilocks on this just below ??!!
Meanwhile, things couldn’t be anything further from that made up historical reference as we wake up and get the week under way, rates maintaining bearish input …
… even THOUGH they remain OVERSOLD and this has would suggest to me a bit of a pause (in the selling) likely warranted … oversold conditions will resolve with time at a price OR some sort of bullish / lower yield activity … But that may just not be today’s business and so, on TO it…here is a snapshot OF USTs as of 703a:
… HEREis what this shop says be behind the price action overnight…
… WHILE YOU SLEPT Treasuries are basically unchanged from Friday's EOD levels after initially opening softer as JGBs reopened sharply lower post-holiday (30y JGB +4.5bps) despite last week’s Nikkei article noting Lifers should be coming into the ultra-long sector. There was some modest mean-reversion into the London session however with USDJPY back to UNCH’d around 144.95, EGBs recovering (periphs outperforming) on risk-off bias across most asset classes (HSP -2.4%, NKY -1.3%, KOSPI -0.8%). Desk flows were muted, with some FM interest seen in steepeners at the London open. Volumes are slightly elevated in intermediates, and overall slightly above averages. DAX futures are +0.4% now, S&P’s showing +11pts here at 6:45am. The DXY is flat and energy complex softer / mixed (CL -0.8%, RBOB -1.1%, TZT +1%).
From some of the news to some of THE VIEWS you might be able to use… here’s SOME MORE of what Global Wall St is sayin’ and these are in addition TO what were noted over the weekend…
BNP - Sunday Tea with BNPP: Risk premium normalises
KEY MESSAGES
Risk premium has normalised according to our metrics, particularly in FX. We have bought the dip in FX carry by going short EURBRL.
But in other asset classes neutral risk premium means risk-reward remains balanced; for Treasuries in particular, more duration supply should support higher term premia.
Additionally, gas price spikes keep the September ECB meeting ‘live’ and long-term Eurozone inflation expectations have now caught up with those in the US.
GS - US Economics Analyst: Rate Cuts (THIS is the one most everyone will be talkin’ ‘bout round the WC … interesting to note they seem to be suggesting IT IS GONNA BE DIFFERENT THIS TIME with rate CUTS sans RECESSION … whatever the case gonna be, this note sure gonna ‘sell some news papers today)
■ Our baseline forecast calls for the FOMC to start cutting the funds rate in 2024Q2. At that point, we expect core PCE inflation to have fallen below 3% year-on-year and below 2.5% on a monthly annualized basis. The motivation for cutting outside of a recession would be to normalize the funds rate from a restrictive level back toward neutral once inflation is closer to the target.
■ Normalization is not a particularly urgent motivation for cutting, and for that reason we also see a significant risk that the FOMC will instead hold steady. The FOMC might not cut because inflation might not fall enough or, even if it does, because solid growth, a tight labor market, and a further easing of financial conditions might make cutting seem like an unnecessary risk. ■ Some Fed officials and investors argue that the FOMC must cut as inflation falls to prevent real interest rates from rising and hurting the economy. We disagree with this logic. Real interest rates should be calculated by subtracting off forward-looking inflation expectations, not realized inflation, and inflation expectations have already fallen to or nearly to target-consistent levels. Moreover, adjusting our broader financial conditions index (FCI) for inflation rather than the funds rate has very little impact on the implied impulse to GDP growth, which is now modest. ■ We are penciling in 25bp of cuts per quarter but are uncertain about the pace. The FOMC might move slowly if its desire to normalize is only lukewarm and it fears further boosting asset prices and strengthening an economy with an already-tight labor market, or it could cut more quickly from a high starting point if it is more confident that the inflation problem is unlikely to return. ■ We expect the funds rate to eventually stabilize at 3-3.25%, above the FOMC’s 2.5% median longer run dot. We have long been skeptical that neutral was as low as widely thought last cycle, and larger fiscal deficits have arguably pushed it higher since. Fed officials could raise their longer run dots if the economy remains resilient with the funds rate at a much higher level or they could conclude—as a recent New York Fed blog post did—that the short-run neutral rate is elevated. ■ Our views have been more hawkish than market pricing this year because we have seen both a lower probability of recession than consensus and a relatively high threshold for rate cuts. This remains true, though the gap has narrowed as recessions fears have faded. We think it is appropriate for the yield curve to be inverted, but not quite as much as it is.
MS - Sunday Start | What's Next in Global Macro: Regulations and the Real Economy
In the euphoria of buoyant equity markets over the last few months, the many challenges facing regional banks have receded into the background. While it certainly has not been our view, a narrative has emerged that the issues in the sector which erupted in March are largely behind us. Moody’s rating downgrades of 10 US banks last week provide a reminder that the headwinds of increasing capital requirements, higher cost of funding, and rising loan losses continue to challenge the business models of the regional banking sector. While the total volume of debt downgraded thus far is relatively small at around $10 billion, Moody’s put six banks on review for possible downgrade and changed the outlooks of 11 banks to negative from stable. Thus, the volume of bank debt facing the prospect of a downgrade is much higher – well over $100 billion.
… While a detailed discussion of a 1,000-plus-page interagency proposal is beyond the scope of this Sunday Start, the document envisages significantly higher capital requirements for much of the US banking sector and extends several large-bank requirements to smaller banks. One such requirement pertains to the impact on capital of the unrealized losses in available-for-sale (AFS) securities. Currently, this provision applies only to Category I and II banks (with >$700 billion in total assets), but the proposal expands it to Category III and IV banks (with >$100 billion in total assets).
A recent paper from the San Francisco Fed shows how the regulatory framework of the banking system affects the real economy. Specifically, the paper demonstrates that banks which experienced larger market value losses on their securities during the 2022 monetary tightening cycle extended less credit to firms. Given the experience of the last 18 months across fixed income markets, extending the impact of such mark-to-market losses to smaller banks would exacerbate the potential challenges to credit formation. As our banking analysts Betsy Graseck and Manan Gosalia note (see here and here), the higher capital requirements implied by the proposed rules would result in less balance sheet capacity for lending and financial market intermediation.
… For the broader economy, this SLOOS shows how the evolution of regulatory policy can weigh on credit formation and overall economic growth. Given the disproportionate exposure of the regional banks to CRE debt that needs to be refinanced, CRE is likely to be the arena where these pressures become most evident – another reason why we are skeptical that the turmoil in the regional banking sector which came to the fore in March is behind us. While the proposed regulatory changes can open doors for non-bank lenders such as private credit, it is important to note that such lending will likely come at a higher cost.
The calendar is so quiet today that even former US Treasury Secretary Summers does not appear to be speaking. While a rational market would not be moving in the absence of new information, markets are rarely rational and so silly stories will be amplified.
We did have the release of German wholesale prices for July, which remain in deflation. The information is useful in assessing price pressures, but as no one believes German wholesale price data will deter the ECB from its autopilot hiking program, the news is not especially market significant.
China’s currency and equity markets have been weakening on the absence of news. The recent trend of worse-than-expected economic data has left investors scanning the horizon for the arrival of some kind of policy rescue. The weekend did not produce any great policy pronouncements, leaving markets somewhat downbeat.
The US consumer is in focus tomorrow with retail sales data. The middle income consumer has more spending firepower than the headline numbers suggest, although they may be prioritizing experiences (Beyoncé for instance) rather than things purchased in stores. UK consumer price data later in the week is worthy of attention, given the three-way split on interest rates at the Bank of England.
With all THAT in mind a few words from a fella at Bloomberg who’s been outta pocket for a couple weeks … Noting his perspective as I’ve always found after being a away for any amount of time — mostly just a weekend — often ‘see the ball much clearer’.
Bloomberg John Authers OpED - Back from vacation and what's in my head
What I Missed Trying to watch the markets as disinterestedly as possible over the last two weeks, from a hammock in Mexico, one thing seemed clear. Someone somewhere was determined to break the 10-year Treasury yield, the most important number in global finance, above the level of 4%. Anthropomorphizing markets, as we’re generally not supposed to do, the yield obviously wants to go above 4%. It was also clear that very many people thought Treasuries were a buy at that level. But it does increasingly look as though the 10-year yield is getting comfortable above 4%.
To recap the story, 10-year yields went through 4% in the first week of July, in response to some second-tier data that looked strong, such as the ADP private sector employment report. It didn’t stay there for long, with the consumer price inflation data for June that suggestedprice rises were coming down fast spurring a large retreat.
But then on July 27, a report that the Bank of Japan was considering a big relaxation of yield-curve control sent it above 4% again. Back down it came, only to surge the following week with the Fitch rating agency’s startling but sobering decision to downgrade the US sovereign credit rating the most obvious catalyst. By last week, with both unemployment and inflation data benign, the yield got clearly below 4% — only for sellers to pounce and force it sharply higher. Beyond the July CPI data themselves, excuses included the producer price inflation numbers the following day, and a loud pronouncement from Bill Gross, the founder of Pimco, that the 10-year should be at more like 4.5%. It now looks as though the breakout has definitely happened:
This matters. A higher bond yield means a higher cost of capital for everyone. And sudden “breakouts” beyond the long-term declining trend in yields have a history of triggering accidents. I’ve published various versions of the following chart many times over the last two decades. Don’t get too excited about exactly where to draw the trend line since the Fed under Paul Volcker slew inflation. Just note how strong that trend was, how financial accidents invariably happened when it was threatened, and that it’s plainly now over:
The most recent accident came when the 10-year bobbled back up above 4% in response to hawkish comments from Fed Chair Jerome Powell in early March; the failure of Silicon Valley Bank and other regional banks soon caused yields to dip. But, compared to previous history when a bond breakout would lead to a major financial incident and lower yields for years, the shock was shallow and short-lived. Now, with data on delinquent loans suggesting that pressures on banks are rising, and some dovish “Fedspeak” that should keep yields lower, they’ve broken out again.
In all, this is quite a “headscratcher,” as Morgan Stanley put it to Lisa Abramowicz in Bloomberg’s Surveillance newsletter. This is true even for those who predicted it. Brent Donnelly of Spectra Markets two weeks ago publicly urged that the time was right to short bonds, largely because he saw growing inflationary pressure. There’s been no added sign of that in the last two weeks. As he admitted:
I am surprised at how well it’s worked so far given the soft US CPI release and the extremely dovish comments from [FOMC members] Williams and Harker. We now have three core Fed peeps endorsing rate cuts in 2024. This is new! This week offers a useful lesson for people who are just starting in the market. The lesson is: It doesn’t always have to make sense.
Will Compernolle, macro strategist at FHN Financial, said the 4% 10-year yield had been “a psychological threshold where buyers will come in to the market off the sidelines, especially the last few trading sessions.” He added:
There's a push and pull from both higher growth prospects in the economy on one side (pushing up yields), and a growing expectation the Fed will execute a soft landing that leads to rate cuts on the other (pushing yields down). This can cause 10s to oscillate a bit based on whatever the latest news suggests, but 4% gives a good return for both dip buyers on one end, and those that think there are more attractive long-term returns elsewhere in the economy on the other end.
James Penny, chief investment officer of TAM Asset Management, who have their highest exposure to bonds in five years, said the volatility was driven by inflation expectations and rate cut speculation, exacerbated by the Fitch downgrade and heavy new issuance which “boosted supply without meaningfully increasing demand.” He said:
I think fundamentally if you look at where markets are, if you look at prospects of a recession, if you look at how high equities have gone, the bond market hasn’t gone up with them. But there are fantastic opportunities in bonds right now. And you may never see this again. If you want to take advantage of that, now is the time.
Making the bullish argument for bonds, Penny suggests that there’s a general agreement that stocks have peaked, while bond yields have risen too far after the fastest interest-rate hiking cycle in many people’s careers. There are plenty of moving parts, of course, including the need for greater issuance as the deficit grows, but the single most important driver — as it has been for at least two years now — is inflation.
David Hay (of Haymaker NL fame) has some real interesting thoughts on the usual Go Long Bonds playbook pre-recession. Basically amounts to-Not Necessarily This Time!
David Hay (of Haymaker NL fame) has some real interesting thoughts on the usual Go Long Bonds playbook pre-recession. Basically amounts to-Not Necessarily This Time!