The 30-year bond was a flop Which helped cause an interest rate pop Though CPI rose A bit less than pros Expected, risk prices did drop Then early this morning we learned That lending in China’s been spurned It certainly seems That Xi Jinping’s dreams Of rebounds might soon be o’erturned
For all the bulls out there, yesterday must be just a bit disconcerting. First, the highly anticipated July CPI data was released at a slightly lower than expected 3.2% headline number with core falling 0.1% to 4.7%, as expected. As always when it comes to CPI data, there were two immediate takes on the result. On one side, inflationistas pointed out that the future will be filled with higher numbers going forward as base effects for the rest of 2024 kick in with very low comparables in 2022. They also point to the medical care issue, a detail I have not discussed, but which has to do with a change made by the BLS that has been indicating medical care prices have fallen all year, but which will fall out of the mix starting in September, thus reversing one of the drags we have seen on CPI. And finally, the rebound in energy prices is continuing (oil +0.4% today) and will be a much bigger part of future readings. This story was underpinned today by the IEA reporting a new record demand for oil in July of 103 million bbl/day. Demand continues to support prices here.
Meanwhile, the deflationistas point to the recent trend in prices, which shows that on a 3-month basis, or a 6-month basis, if annualized, CPI is really only running at 2.4% or 2.9% or something like that. The implication is because we have seen a reduction in the monthly number lately, that will continue. As well, they make the case that China’s deflation is a precursor to lower US inflation with, I believe, a roughly 6-month lag. Perhaps the most interesting take I saw was that the Fed has now achieved their goal of an average PCE of 2% if you take the last 14 years of data. The idea is that Average Inflation Targeting was designed to have the economy run hot for a while to make up for the ‘too low’ inflation that has been published since the GFC. And now, that average is 2.07% for the past 14 years. (To me, the last idea is a chart crime, but I digress.)
The problem, though, for the bulls, is that the market’s behavior was not very bullish. Although the initial move in Treasury yields was lower, with the 10-year yield falling 6bps right after the release, the 30-year Treasury auction that came later in the day was not nearly as well-received as the shorter dated paper seen earlier in the week. The bid/cover ratio was only 2.42 and it seems that the market may be feeling a little indigestion from all the new paper just issued, as well as the prospects for the additional nearly $1.5 trillion left to come in 2023. It is not hard to believe that longer end yields could rise further as the year progresses. The upshot was 10-year yields rose 10bps on the day and are unchanged from there this morning.
Similarly, in the equity markets, the initial surge on the back of the slightly softer CPI was unwound throughout the day and though all three major indices ended the day in the green, the gains were on the order of 0.1% or less, so effectively unchanged. Looking at futures there today, all three indices are unchanged from the close as investors and traders look for their next inspiration. Meanwhile, I cannot ignore that overnight, Asian equity markets all fell, with the CSI 300, China’s main index, down -2.30%. As well, European bourses are all lower this morning, mostly on the order of -1.0%. Overall, this is not a positive risk day.
One of the things adding to the gloom is the financing data from China released early this morning. New CNY Loans fell to CNY 345.9 billion, less than half the expected amount and down from >CNY 3 trillion in June. M2 Money Supply there also grew more slowly than expected at just 10.7% as it seems that China’s debt woes are increasing. China Evergrande was the first Chinese property company that gained notoriety for its problems, but Country Garden was actually the largest property company in China and now that looks to be heading toward bankruptcy.
A quick tour of China shows it has a number of very big problems with which to contend. Probably the biggest problem is demographics as the population begins to shrink. However, two other critical issues are the massive amount of debt that is outstanding there (not dissimilar to the US situation) but much of it is more opaque sitting on the balance sheet of local government funding vehicles. Just like in the West, this debt will not be repaid in full. The question is, who is going to take the losses? In China, the central government is trying to foist those losses on the local governments, but that will be a long-term power struggle despite President Xi’s ostensible powers. Finally, the massive youth unemployment situation is simply dry tinder added to a very flammable mixture already. This is not a forecast that China is going to implode, just that the claims that it is set to ascend to global superpower status may be a bit premature.
(By the way, for all of you who think a BRICS gold backed currency is on the way, ask yourself this question. Why would India and Brazil want to link up with a nation with awful demographics and a gargantuan debt problem and link their currency to that?)
Finishing up, we have a bit more data this morning led by PPI (exp 0.7% Y/Y, 2.3% Y/Y ex food & energy) and then Michigan Sentiment (71.3) at 10:00. With CPI already released, PPI would need to be dramatically different from expectations to have much of an impact at all. There are no Fed speakers today, but yesterday we heard that there is still more to do by the Fed from both Daly and Bostic, and Harker did not repeat his idea that cuts were coming soon.
The dollar is mixed today, with Asian currencies under pressure, EEMEA and LATAM currencies performing well and the G10 all seeming in pretty good shape, although NOK (-0.7%) is under pressure after a much softer than expected CPI number yesterday has traders unwinding some future interest rate hikes.
Speaking of future interest rate hikes, the Fed funds futures market is down to a 10% chance of a September rate hike by the Fed, although there is still a ton of data yet to come, so that is likely to change a lot going forward. My sense is that a little bit of fear is building in risk assets as despite some ostensible good news, with lower inflation and less chance of a Fed rate hike, risk is under pressure. One truism is if a market cannot rally on good news, then it is likely to fall, especially if something negative shows up. In that case, I suspect that we could see weakness in equities today, weakness in bonds and strength in the dollar before it is all over for the week.
Good luck and good weekend
Adf