Cold and Hot
Doug Noland
Too much ice, not enough electricity.
For others, brutal cold.
Weather extremes were only one facet of such an “interesting” week.
Much to Beijing’s chagrin, Taiwan’s DPP party won a third term, with a gutsy, independent-minded new President taking charge.
Story to continue…
The Houthi’s scoff at U.S. strikes and threats, vowing to ratchet up Red Sea attacks.
Iran lobs missiles into Pakistan (and Iraq and Syria), and the Pakistanis respond in kind.
The IDF intensifies airstrikes in Southern Lebanon, as three months of tit-for-tat risk Hezbollah war eruption on Israel’s northern border.
The S&P500 and Nasdaq100 trade to new all-time highs.
Here at home, frigid conditions were in stark contrast to hot economic data.
And there’s no magic here.
Contain those happy thoughts of a soundly resilient U.S. economy.
Work diligently to manage complacency.
After all, we’re only witnessing the consequences of last year’s major loosening of financial conditions – and confirmation that the “dovish pivot” is a worthy addition to the long list of Fed policy blunders.
More importantly, it’s all part of one incredibly prolonged and erratic “terminal” Bubble phase, which seduces only to punish later.
December Retail Sales rose a stronger-than-expected 0.6%, confirming the strength of holiday spending.
Sales were up 5.6% y-o-y, with Retail Sales Ex-Gas rising 6.7%. “Control Group” sales (used in GDP calculations) were up 0.8% versus estimates of 0.2%.
Housing Starts (1.46 million) and Building Permits (1.495 million) both beat forecasts.
While Existing Home Sales were somewhat below expectations, the lack of supply continues to be a pressing issue.
Inventory dropped an additional 130,000 to a historically depressed one million, the low back to last March (20-year average 2.28 million).
Little wonder the National Association of Home Builders Market Index jumped a much stronger-than-expected seven points to a five-month high 44 (expectations 39).
Weekly Mortgage Purchase Applications rose 9.2% to the highest level since July, while Refinancing Applications surged 10.8% to the high back to May.
Squinting is required to observe (trumpeted) labor market loosening.
Weekly Initial Jobless Claims dropped 13,000 to 187,000, the low since September 2022.
Declining for a third straight week, Continuing Claims fell to 1.806 million, the lowest number back to the week of October 13th.
For perspective, the 20-year average is 3.175 million.
At 78.8, preliminary January University of Michigan Consumer Confidence absolutely blew away expectations.
Consumer Sentiment surged nine points to the high since July 2021, a report also preceded by a big stock market rally.
The Current Conditions component jumped 10 points, while Expectations rose 8.5 points (both highs since July ’21).
From Bloomberg (Vince Golle):
“The consumer sentiment survey showed the pickup in optimism was broad, with improvements across age, income and political affiliation.
More than half of households expect their incomes to grow at least as fast as inflation, the highest share since mid-2021…
Meanwhile, stock market expectations were the strongest in more than two years...
Consumers’ perception of their current financial situation rose to a two-year high, while expectations for future finances climbed to the highest since 2021.
Buying conditions for durable goods rose to a nearly three-year high…”
It's increasingly challenging for the bond market – and Fed officials – to downplay the odds of a meaningful upside surprise in U.S. economic activity.
And tight labor market conditions increase the likelihood of already elevated inflation refusing to follow the nice glide path to 2%.
It’s worth noting that the UK and Canada both reported stronger-than-expected inflation.
UK headline inflation at 0.4% for the month (4.0% y-o-y) - and Core CPI up 5.1% y-o-y - made for an unpleasant Bloomberg headline: “UK Inflation Shock Sets Gilts Up for Worst Ever Start to a Year.”
Canada’s core inflation jumped to 3.65%, 0.3% above expectations.
Bloomberg: “Core Inflation Spurs Traders to Pare Bets on Canada Rate Cuts.”
Bond market gyrations are a cause for concern for a bullish marketplace confident the storm has passed.
Two-year Treasury yields surged 24 bps this week to 4.38%, fully reversing the previous week’s 24 bps drop.
Ten-year yields rose 18 bps to 4.12%, with yields up 24 bps during the first three weeks of 2024.
MBS has returned to its hyper-volatile 2023 ways.
Yields jumped 28 bps this week to 5.55%.
This follows the 24 bps drop during the second week of the year and week one’s 24 bps surge.
The rates market ended the week pricing a 49% probability of a rate cut by the March 20th FOMC meeting, down from last Friday’s 83% - and half of the 100% to end 2023.
The market ended the week expecting a 3.98% Fed funds rate for the December 18th meeting, up from last Friday’s 3.65% and the year-end 3.75%.
Markets are now pricing 135 bps of 2024 cuts, down from last week’s 168 bps.
January 18 – Bloomberg:
“Trading has surged to a nine-year high in China’s onshore swaps market, an increasingly popular one-stop-currency-shop for everyone from foreign to local to state banks and corporates, all happy to bypass traditional FX venues.
Attractive rates for those with dollars to lend, strong demand for the US currency in China’s banking system and even shadow intervention from officials keeping the yuan in check are some of the suggested reasons that have driven one measure of client activity to the highest since 2015.
Swaps are becoming more common tools to manage currency positions, with a market share now of 10%, according to Bloomberg calculations, compared to about 75% for old school buying and selling via so-called spot trading.”
Reading this week of the boom in Chinese derivative swaps trading, my thoughts returned to early 1998.
It was a February (as I recall) Financial Times article that detailed surging trading volumes in Russian currency and bond derivatives.
The derivatives boom was understandable.
Russia was acutely vulnerable to similar dynamics that took down the Asian Tigers the previous year.
Significant speculative leverage created fragility, along with intense demand for bond and currency hedges.
After reading the FT article, I was even more convinced that market dislocation was inevitable.
A de-risking/deleveraging episode would find players on the wrong side of a mountain of downside derivative exposures, facing panicked selling in an illiquid marketplace.
Obviously, China to begin 2024 is in a much stronger position than Russia in early 1998.
But there is today an elevated risk of disorderly currency trading.
I suspect Beijing has leaned on currency derivatives to conserve international reserve holdings.
China’s major banks have been directed to support the renminbi, leading to a surge in currency futures contracts and derivative swaps trading.
Such activities do reduce the amount of renminbi selling and the need for central bank support (dollar sales to buy renminbi). But they come at a potentially steep cost.
As a mountain of derivative exposures accumulate, risks rise for a bout of derivative-related panic selling, illiquidity and dislocation.
The market mantra in 1998 was “the West will never allow a Russian market collapse.”
Markets have pretty much remained 100% confident that Beijing would never tolerate a currency crisis.
Acute underlying fragility, confidence in a powerful market backstop, and mountains of derivatives are the recipe for market trouble.
The Shanghai Composite’s 1.7% decline this week pushed y-t-d losses to 4.8%.
The Hang Seng China Financials Index sank 4.3% this week (down 7.5% y-t-d), with the index sinking to lows back to November 2022.
Renminbi losses were held to a minimum (-0.36%), which is more than can be said for the vulnerable Japanese yen (-2.19%).
I can’t help but think that the dollar-denominated EM debt market is sending an important message.
Ten-year yields were up 35 bps this week in Colombia (7.33%), 26 bps in Panama (7.12%), 26 bps in Peru (5.40%), 25 bps in Turkey (7.67%), 19 bps in Mexico (5.71%), 17 bps in Indonesia (5.15%), and 14 bps in Brazil (6.15%).
This puts the three-week yield surge at 69 bps in Columbia, 66 bps in Turkey, 49 bps in Panama, 48 bps in Peru, 42 bps in Indonesia, 34 bps in the Philippines, 30 bps in Mexico, 29 bps in Chile, and 23 bps in Brazil.
Could the message be, “Get prepared for global de-risking/deleveraging and associated liquidity issues.”
European peripheral bonds are faring only somewhat better.
This week’s 40 bps jump pushed the y-t-d Portuguese yields surge to 52 bps.
Yields are up 30 bps y-t-d in Greece, 26 bps in Spain, and 18 bps in Italy.
Yields were up 16 bps this week (up 32 bps y-t-d) in Germany and 15 bps in France (up 27bps).
This week’s 14 bps jump pushed the UK y-t-d surge to 39 bps.
Australian 10-year yields jumped 22 bps this week (up 34 bps y-t-d).
Closer to home, Canadian 10-year yields surged 27 bps to 3.49% (up 38 bps y-t-d).
Was Q4’s spectacular squeeze rally merely a head fake in an ongoing global bond bear market?
It wasn’t that many months back in October, with global markets fretting myriad casualties from spiking global yields.
A 2024 global yield spike would catch everyone by surprise – and poorly positioned.
The fraught geopolitical backdrop – with increasingly clear inflation ramifications – is not helpful.
January 16 – Associated Press (Jon Gambrell and Lolita C. Baldor):
“A barrage of U.S., coalition and militant attacks in the Middle East over the last five days are compounding U.S. fears that Israel’s war on Hamas in Gaza could expand, as massive military strikes failed to stall the assault on Red Sea shipping by Yemen-based Houthis.
Even as the U.S. and allies pummeled more than two dozen Iran-backed Houthi locations on Friday in retaliation for attacks on ships, the Houthis have continued their maritime assaults. ´
And Tehran struck sites in Iraq and Syria, claiming to target an Israeli ‘spy headquarters,’ then followed that Tuesday with reported missile and drone attacks in Pakistan.
The chaotic wave of attacks and reprisals involving the United States, its allies and foes suggested not only that last week’s assault had failed to deter the Houthis, but that the broader regional war that the U.S. has spent months trying to avoid was becoming closer to reality.”
January 15 – Bloomberg (Alex Longley):
“The cost of war-risk insurance for vessels sailing through the Red Sea is spiraling, adding a further potential impediment to trade passing through a waterway already labeled too dangerous for merchant shipping by the US Navy.
Underwriters are now charging between 0.75% and 1% of the value of the ship to sail through the region, according to people familiar with the matter, jumping significantly since US and UK airstrikes targeted the Houthi rebels in Yemen at the end of last week.
Just a few weeks ago, quotes for cover were about one tenth of that amount.”
January 14 – Wall Street Journal (Rory Jones):
“After 100 days, Israel’s war with Hamas is turning into a protracted conflict with no clear end, threatening to spread across the Middle East, disrupt global trade and bog down the U.S.
One of the biggest geopolitical events this century, the war has swung from a Hamas attack on Oct. 7 that Israel says killed 1,200 people to the Israeli military’s ferocious retaliation against the militant group in Gaza.
More than 23,000 Palestinians have been killed, mostly women and children, Palestinian authorities say, a number that doesn’t distinguish combatants from civilians, and nearly 70% of Gaza’s 439,000 homes and about half of its buildings have been damaged or destroyed.”
January 14 – Wall Street Journal (Chun Han Wong):
“For eight years, China has raged against Taiwan’s ruling party, accusing it of pursuing a separatist agenda that must be confronted with economic muscle and shows of military might.
On Saturday, Taiwanese voters handed the Democratic Progressive Party another ringing victory, all but ensuring that those tensions will persist—or even intensify—over the next four years, and cementing the island’s status as a flashpoint between Washington and Beijing.
Lai Ching-te’s win is likely to stoke anxiety in Beijing, while also fueling concern in Washington that China may lean toward the use of force to bring Taiwan’s democratic government to heel.”
January 16 – Reuters:
“Russian President Vladimir Putin said… that Ukraine's statehood could suffer an ‘irreparable blow’ if the pattern of the war continued, and Russia would never be forced to abandon the gains it had made.
Putin made his televised comments a day after Switzerland agreed to host a global summit at the request of Ukrainian President Volodymyr Zelenskiy.
Putin dismissed ‘so-called peace formulas’ being discussed in the West and Ukraine and what he called the ‘prohibitive demands’ they entailed.
‘Well, if they don't want (to negotiate), then don't!...
Now it is quite obvious, not only (Ukraine's) counter-offensive failed, but the initiative is completely in the hands of the Russian armed forces.
If this continues, Ukrainian statehood may suffer an irreparable, very serious blow’.”
January 19 – Bloomberg (Jonathan Tirone):
“Iran is frustrating international efforts to examine its nuclear program as it speeds up its production of uranium enriched close to the level needed for weapons.
International Atomic Energy Agency inspectors figure Iran now has sufficient quantities of highly-enriched uranium to build several atomic warheads, Director General Rafael Mariano Grossi told Bloomberg…
‘It is a very frustrating cycle,’ Grossi said.
‘We don’t understand why they don’t provide the necessary transparency.’”
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