There is an elephant in the room

Outlook

Payrolls put the kybosh on the idea of the Fed raising rates again in Oct. The probability in CME table went from 64.2% a week ago to 20.5% just before noon on Friday. That leaves December—but no. For the Dec 9 meeting, the CME has only a 17.4% probability of a hike and 65.7% probability of rates on hold.

We always say institutional factors trump economic data and the central banks are the top institution. Ah, but now we have the bond drama. The 10-year went from 5.222% at 7 am to 5.266% by noon. The bond gang wants inflation tamed by rate hikes and if the Fed is not giving it to them, the yield will rise. At a guess, the yield outweighs the Fed and thus supports the dollar.

But there is an elephant in the room. The core PCE 3-mo annualized stands at 2.05% as of August. It had been 2.3% in July. The Fed notices. Warsh notices. Of course the core excludes food and energy, the very things the public is mad about. But a hold is not too stupid given this data.

We get the ISM service PMI today. It could be interesting if prices paid are higher, as they were with manufacturing. The trend is already rising.

About the Yen: The gyrations in the dollar/yen look small on the chart but are actually pretty big. There is a lot of talk about who is locking in what, but we wonder if there isn’t a simpler explanation: for many, including the Japanese big houses, the yen is a safe haven. This trails back to geopolitical uncertainty and we all know where that starts.

Fly in ointment: A more hawkish Fed was supposed to be the cure for high yields, but there are too many negative factors all at once. The diesel story failed to tame yields. Realistically, there is no progress in the war and therefore oil remains high. Equally as big a factor is distrust of central banks and the fiscal stance of governments—in other words, both sides of government that deal with money.

Bloomberg zooms in on the credibility of TreasSec Bessent, who “has made economic predictions that have been off the mark, including the housing market and inflation. Bessent's optimistic prognostications have hurt his credibility, according to Douglas Holtz-Eakin, president of the American Action Forum.

Bessent's real test lies ahead, as he will need to work with Democrats to pass economic measures and broker a political compromise on the nation's debt ceiling.”

Then there is AI competing for capital. Some of its debt is private and under the radar. Not affecting yields directly but in the air is the vast popular uprising against data centers, with some 70% of voters against them and wanting to have been consulted first. No wonder: our electric bill was $78 a year ago and $190 today. 

Off on the side, the Brazilian run-off later in Oct election may give us Bolsonaro, who will be good for Brazilian assets. Spain announced a snap election in the face of protests about a housing shortage. The FT reports over 50% of young adults in Spain live with their parents.

The US midterms are a month away and polls show the Dems will trounce the Trumpies, but we have learned not to trust polls.

Forecast

The bond crisis is not limited to the US. Other G7 names in trouble are the UK, France, Germany and Japan. See the Bloomberg chart again. Of these, the US and Japan are the only two considered Safe havens. The solution is fiscal restraint, a political rabbit hole. Coupled with a one-time tax increase, a fat reduction in central government spending could cool tempers and nerves. Alas, nobody expects this fix—it could so easily lead to recession.

That leaves the dollar—and gold.

Markets do not like politics and avoid drawing conclusions from political developments. That doesn’t mean the French crisis is going away, but it may mean some pullback from extremes. In the US, we can find nothing to fix the bond market’s disdain for current management.