Fed speakers are already mentioning “modest” cuts ahead and “delay is not a bad thing”

Outlook

Today the Richmond Fed releases its manufacturing index, the Philly Fed its non-manufacturing index and the IMF releases the World Economic Outlook, which may ruffle some feathers.

There is really only one subject on the table—the rise in US yields that is supporting the dollar. Why are yields rising? Let me count the ways:

1. Ukraine, Israel, Taiwan.

2. Trump.

3. Both presidential candidates offering really big increases in the national debt.

4. Sticky inflation persisting because of robust growth that could stay the hand of the Fed.

5. Consumer perception of inflation persisting that becomes a self-fulfilling prophecy.

As for staying the hand of the Fed, Reuters notes that the terminal rate we can expect when all the cutting is done next year has been dialed back severely “close to 3.5% next year and less than 150 basis points from the current policy rate.”

Reuters also notes “… the New York Fed's estimate of the 10-year Treasury 'term premium' - a key measure of the compensation investors demand to hold long-term government debt securities - has risen to its highest level of the year, at more than 14 bps. It's been negative for most of the year.”

Fed speakers are already mentioning “modest” cuts ahead and “delay is not a bad thing.”

Yesterday Goldman Sachs said the Trump policies would take the euro down below parity. “A 10% global tariff and 20% levy on Chinese imports, combined with the stimulus of domestic tax cuts, could cause the dollar to rally sharply and the euro to drop 8% to 10%, Goldman's Michael Cahill told clients.”

Savvy market commentator Chandler goes out on a limb: “The US two-year premium over Germany continues to push higher. It is approaching 190 bp today. It bottomed near 135 bp, the least since May 2023 on September 18, the day of the last Fed meeting. The euro has not traded below $1.08 since early August. A break of the $1.0780 area could spur a test on $1.07.”

We see two problems. While it’s nice to have been ahead of the curve on the Fed, the fact remains that on the charts, the dollar is wildly overbought. The tenure of the move is already abnormally long, considering the history of big moves. We keep expecting a pullback/consolidation/correction and it keeps not coming. When it does come, it could be a doozy. We will need a big trigger for that.

Second, the dollar is not in the Fed’s wheelhouse. It belongs to the Treasury. The Treasury is headed by a former Fed and we have to imagine the two outfits speak with one another. A lot. It’s not silly to ask whether TreasSec Yellen wants a less-rip-roaring dollar and whether she has the ability to talk the Fed into a Nov cut that it otherwise would not do.

About Japan: Yesterday the FT addressed the renewal of the yen downfall back over 150, blaming the dovish attitude of the new PM and including an odd sentence--
“investors bet on a slower pace of interest rate rises from the Bank of Japan, at a time when the US Federal Reserve is also expected to cut rates more slowly than previously thought.“

“The currency’s renewed decline last week prompted Japan’s top currency official to warn that he was monitoring ‘speculative moves’ in the market ‘with a high sense of urgency’.

Japan spent a record ¥9.8tn ($65bn) from late April to May to boost the yen.”

The implication is that if the BoJ is not going to raise rates, the yen will continue to slide back towards 162 and the carry trade is safe again—unless the MoF intervenes. We should probably expect intervention to take place without any warnings ahead of time, since clearly warnings have not worked. The BoJ/MoF are the most skilled current market interveners on the planet with the most experience of the trader mindset.

The FT doesn’t mention the upcoming Parliamentary elections and the renewed commitment to the military build-up. The Japanese Constitution forbids Japan from ever again declaring war, but defense spending is not soft and Japan has recently won kudos from the AUKUS team for renewed commitment.

Forecast

As noted above, it would take a giant trigger to halt the rise in US yields. That trigger could well be the US presidential election, held on Nov 5 but without a clear winner for several days or even a week after that. In the meanwhile, we could potentially get some data surprises and/or notes on perspective from central bankers, but it’s hard to see what could overrule the rising yield differential favoring the dollar. We still expect a correction at some point, but fear of that is receding.

US Political: PredictIt has Trump in the lead, but remember, Trump supporters fixed the race with a few well-placed million-dollar bets, taking it away from the average Joe.

The Silver collection of high-quality polls has Harris just squeaking by on the national level and net losing in the swing states.

Then today Reuters reports its poll with Ipsos that restores Harris to 46% vs. Trump as 43%.

As for the Musk shenanigans, it’s more than half clear they are illegal—you cannot offer money for votes or for registration to vote. Ben&Jerry offered a free ice cream cone to people with the “I voted” sticker and got a cease-and-desist letter from the Justice Dept in short order. Musk has upped the stakes to a million dollars.

It’s an interesting issue because the current Justice Dept is as slow as molasses. If it had been on the ball, Trump would be in jail now, not running for office. Second, Musk is the beneficiary of billions of dollars in US contracts. Billions. Surely there is a conflict of interest in here somewhere—shades of Teapot Dome. Third, it’s unseemly. That’s an odd word to use in the context of the rowdy, barely literate Trump crowd, but Trump’s circus act tries to awake false memories of good old days—but the good old days were a lot more dignified. At some point the crowd could turn on Trump and Musk for just this reason. 

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