The Morning Hark - 27 Sept 2023
Today’s focus...Price action remains the key with little of note on the docket. We take a layman’s look at the basis trade and an escalation path to currency intervention.
Prices are at 7.05 BST/2.05 EST, with changes reflecting movement from midnight BST
Oil - Brent and Crude December futures holding onto their gains overnight with the pair currently sitting at 93.20 and 89.70 respectively. Tighter supply back in focus and railroading any thoughts that the risk off environment would help temper oil’s rally. The Saudi and Russian production cuts, the additional export ban of fuel from Russia and now a consistent drawing from US fuel inventories all helping oil’s cause higher.
EQ - Asia equity markets getting some welcome relief overnight with small gains as US yields back off a touch from their highs. The Nikkei, Hang Seng and Kospi futures all up small at 32,140, 17,646 and 328 respectively.
The Nasdaq and S&P futures similarly smalls in the green with the pair now at 14,760 and 4329 respectively. Some much needed respite after the indicies all took a battering yesterday in the face of higher yields. The 3 major US indicies all closing at three month lows.
Gold - Gold Dec futures continuing to lose its shine overnight as it trades lower again to 1915. Fed hawkish speakers, yields on their highs and the stronger USD; all in all not a good backdrop for gold. US government shutdown worries, seen as gold positive, have been brushed aside in favour of the yield play. On those talks McCarthy was on the tapes last night saying that the stopgap government funding bill will be put to the House on Friday.
Chart wise the price action is ugly and we are starting to get to major downside levels. A break of 1875 would see a test of the year’s lows down towards 1800.
FI - US yields backing off a touch in Asia from their recent highs with the US2y and US10y trading currently at 5.07% and 4.54% respectively. This on a day when 30y US mortgage rates hit a new 23 year high at 7.78% as the man in the street is starting to pay heavily for the late to the party “transient inflation” Fed. Anyway for those that didn’t have time yesterday to read them, I post a couple of useful articles below. The ever excellent Concoda has a piece on the money market plumbing system which lays it out in a very clear and easy to understand manner. Also JPMorgan’s take on the rising fiscal deficit. Well worth a read and listen to.
European yields unsurprisingly closed higher with the German 10y yield closing at 2.81% and the Italian 10y yield at 4.73%.
UK gilt yields bucked the trend with them closing flat at 4.33%.
JPMorgan - Implications of a rising federal deficit
FX - We got the 106 close for the USD Index so further upside expected as we currently sit at 106.25. The JPY, EUR and GBP all continue to be on the back foot currently at 149.10, 1.0560 and 1.2143 respectively.
FX expiries of note today. The EUR sees €1.5bn roll off again at 1.06 with over €1bn between 1.0550/75 and in NZDUSD we have NZD 1.3bn at 0.5945; currently at 0.5930.
One other thing to mention was that traders were suggesting that Chinese state banks had been in the onshore Yuan market selling USDs to support the Yuan.
Others - Bitcoin and Ethereum still retaining key levels overnight. Currently the pair at 26,265 and 1593 respectively.
Date Recap
US consumer confidence came in lower than expected dropping to a 4 month low.
New home sales were a shocker with a big downside miss.
Regional survey wise Richmond and Dallas Fed beat expectations but remain in benign territory.
Central bank speakers
ECB’s Simkus wouldn’t rush with answer on rate cut timing.
Muller is not expecting more rate hikes as things stand.
Holzmann on the hawkish side with his “can’t exclude further rate hikes”. He was also happy to see “rates stay high with economy strong”. I’d hate to see a weak economy!
Fed’s Kashkari, the hawk that he is, was very specific when claiming that he “put a 40% probability on a scenario where the Fed will have to raise rates significantly higher to beat inflation”. He went on with his percentages when claiming he saw a “60% probability of soft landing outcome”.
Bowman out hawked him though as she expects “that further hikes will likely be needed to return inflation to 2% in a timely way”.
Basis Trade
Lot of chatter of late regarding this trade and how it has been fuelled by the Fed’s inflation fight and the US government’s insatiable appetite for borrowing. The FT have done a Big Read about it and it is well worth a look.
We are a year on from the disastrous UK “mini-budget” engineered and delivered by the dynamic duo of Truss and Kwasi which led to the BoE having to step into the LDI market to support UK pension funds. If the Bank for International Settlements and the US Federal Reserve are to be believed we could be on the cusp of a much larger problem than what happened in the UK a year ago.
The basis trade is basically a trade for very small gains but put on in large sizes (almost always with leverage) where the participant sells US treasury futures and buys US bonds. The latest CFTC data on futures from last month suggests that shorts in the futures have risen to an all time high of $900m. They believe that if there were to be market dislocations these could escalate quickly like we witnessed with the LDI saga.
Outwith such market dislocations, further potential risks could be driven by the futures exchanges demanding greater collateral, to trade such products, from the market participants. Equally banks, through their prime broker departments, could either step back or cut back on the leverage they offer or alternatively ramp up their fees. Either move would eat into the hedge funds profits from trading such a strategy and potentially force them to exit these positions.
As we’ve seen with various treasury tantrums in the past, Sept 2019 and March 2020, things can get ugly very quickly. Goldman Sachs, maybe not surprisingly, claims that risks are low due to the fact that the leverage involved, this time around, is a lot lower than previous crisis times. Definitely worth keeping an eye on and reading the FT piece which explains the whole trading process in a lot more detail.
As an aside a lot of these issues have been created by the government and regulators. Since the GFC more regulation has been levied on the banks and on that basis they have step back from providing liquidity into various markets, such as the US treasury market. One consequence of this is the fact that the hedge funds have stepped into the void and picked up the slack hence making it more likely they will participate in such basis trades as part of their overall trading strategy.
One last point, in previous times of stress, the Fed have always stepped in to calm and bail out the market so many see it as a relatively “risk free” trade. The higher for longer play by the Fed will also continue to fuel the interest in the trade. 10y at 5% anyone? Let’s see how this all plays out.
BoJ Intervention
As we get closer to 150 in USDJPY. I thought it would be useful to reflect back on the escalation path of FX intervention from the jawboning to the actual physical intervention. A lot of these are old news but often good just to have a refresher.
Language such as “monitoring developments in currency markets”
“Sudden/abrupt/rapid” movements in currency markets are “undesirable”. In addition markets are “not reflecting fundamentals”.
“Excessive” is introduced next to describe the price movements alongside “clearly” in addition to referring to FX moves as “speculative”.
Readying for action is normally reflected with the phrase “we are ready to take decisive action” which would suggest some action is imminent.
Price checking is the step prior to actual intervention whereby the BoJ will call round selected Japanese banks and ask for a level of USDJPY. Even though they do not deal the act of them asking normally makes the banks, who have been contacted, sell USDJPY in anticipation of intervention and they will also spread the news around the market to encourage more selling.
Same as 5 but this time the BoJ actually do sell USDJPY. This may happen in waves.
Finally co-ordinated intervention with other major central banks involved. This would generally happen early NY hours to include the US. This obviously has the most effect on the markets.
As we have said many times in the past, intervention has the best chance of turning the tide when it is coordinated and we see no incentive for the US to get involved at present especially as fundamentals actually do not support such a move. Given there is an over 5% difference between US and Japanese rates it would be hard to justify any help from the US as supporting economic fundamentals.
The Day Ahead
BoJ minutes for July told us little new. There was agreement on maintaining the ultra loose monetary policy. However members did disagree on when would be appropriate to end the policy and also on the trajectory of corporate wage growth.
Australian CPI Coming in as expected, higher on the month, literally fuelled by fuel prices.
The rest of the day sparse to say the least. Durable goods in the US and a single ECB speaker. Watch yields again I guess.
👍 If you found this morning’s briefing helpful, please consider giving it a ‘Like’ at the bottom of the page. It only takes a few seconds and helps our free commentary reach a wider audience.
Follow the latest market narratives through our curated research & commentary channels on Harkster.com
All times in BST (EST+5 / CEST-1 / JST-8)
Wednesday
US Durable Goods Orders consensus -0.5% vs previous -5.2% (13.30 BST)
ECB Speakers
Enria (13.00 BST)
Good luck.
The information provided in this post is for general information purposes only. No information, materials, services, and other content provided in this post constitute solicitation, recommendation, endorsement or any financial, investment, or other advice. Seek independent professional consultation in the form of legal, financial, and fiscal advice before making any investment decision.