This weeks’ two big inflation reports will offer perspective

Outlook

Payrolls on Friday surprised with a big gain, 165,000 new jobs rather than the 65,000 forecast. Also the unemployment rate fell from 4.2% to 4.1% although average hourly earnings are up only 0.4% ($32.75). 

This weeks’ two big inflation reports will offer perspective. Tomorrow it’s CPI and on Friday, which is a Friday the 13^th, it’s PPI.

What we want to see is whether either one moves the Treasury yields by a significant amount. So far we have a small jump on jobs, but if inflation looks scary, we could get a bigger jump. Remember that the Cleveland Fed and others expect no relief from higher inflation. How much higher does it have to be to halt the falling yields? Remember we had no data release last October so no y/y this time. Then there is fly in the ointment—a 10-yyear auction tomorrow right after the CPI release, which is accidental but weird.

We think the stock market is more important the yield story, simply because the yield story is so confusing. Will the bond gang, including foreigners, demand more inflation premium without regard for the equity gang’s case of the heebie-jeebies?

If the stock market keeps falling, the Fed is expected to become dovish on the recession fear theory. As usual, we don’t understand the bond market. On the one hand, bonds are the obvious place to flee to as a hedge to the backlash against tech/AI. On another, bonds are attractive today if you see the Fed retreating from hikes in the coming year, regardless of inflation. If the Fed thinks it can see a lessening of the rate and/or the stickiness, maybe even December is getting some doubt.

The CME betting doesn’t show it—yet. The probability of a hike at the Dec meeting is still 78%, up on the week and the month. And for the March meeting, it’s 39.1% the same after the Dec hike and 44.6% for another hike to 4.25-4.50%. That’s pretty close and while the numbers don’t yet signal a halt in hikes, the chatter does. We have a slew of Fed speakers this week but pay no heed—it’s the stock market that counts.

Stock market

See the summary of the stock market situation above. One key deduction leads ius to a forecast: the rate of growth of tech/AI was excessive. It resulted in weird financial statements that analysts found too abnormal to be sustainable. More transparency is needed.

Note that it’s not growth of the sector itself, but rather the rate of growth. It had gotten frightening. Fear spread from smart analysts to the investing crowd. Crowds behaved as they always do, with panic.

Now comes the culling of the herd. This doesn’t have to mean outright failures, although it may, but rather a slowdown in borrowing, capital spending, cross-client funding, IPO’s, etc. A drop in capital spending would give relief to the crowding out effect, meaning yields don’t have to shoot the moon. To the extent capital spending is behind GDP growth, growth will be reduced, and so will employment.

Along with other FX analysts, we hate talking about the stock market. Bunch of flibbertigibbets! Wel, no. This equity market pullback is perfectly rational. Maybe the earlier build-up in valuations was irrational, but this correction is based on multiple sane reasons. The implication is that when rationality in valuations is restored, the correction will end. Maybe the revised valuations will still be very high, maybe even too high on historical comparisons, but after all, the digitization of the world is a Big Deal. This is electric light and railroads.

Now on to the important stuff. What does this mean to the FX market? First, the Shock sends traders to the safe-haven dollar, as we see. As the re-valuation and slowing of capital spending process develops, it will dawn on economists that growth will go down, but perhaps not enough to dent the verdict of a robust and resilient economy. Trump couldn’t harm it and neither can AI.

Some try to make hay out of tech and AI imports now about a third to two-thirds of the US trade deficit, up from a far smaller share only three years ago. At the same time, US exports of goods and services are about 12% of exports. They sell us hardware, we sell them the resulting product. Net-net, it’s not quite a wash, but it’s not a catastrophe, either. We say it can be ignored when it comes to dollar valuation. People want dollars for reasons other than buying US exports.

As the re-valuation process comes to a settlement (it never really ends), less pressure on yields will be the central point. We may still get higher yields on inflation and the massive US debt, but the yield curve should normalize. We could even see the Fed pull back from any hikes in 2027.

That is when the dollar can pull back. It will be rocky, because we can also expect capital inflow when everyone sees the bottom is in.

We can’t invest too much in this scenario. It’s just one of many possible outcomes. It may be the authentic bubble bursting. It may be a very long, unhappy hangover. There’s still the Iran war to worry about, not to mention upheaval and disorder in Washington. But it’s not a bad theory and it’s emerging as the most likely course of events.

Forecast

Note that Wednesday is Veterans Day in the US and the bond market is closed (equites are open). It’s also Remembrance Day in Canada.

The longer the equity sell-off lasts, the more likely it gets that analysts start talking about an overall economic slowdown. That tech/AI capital spending is central to the overall GDP growth and if they pull back, it reverberates. Do global investors dump dollars as they dump tech/AI? That would make the current dollar upmove move a short-term move.

If we expect a hammer on growth, by definition that means a drop in demand and thus inflation. We have a good jobs report and an expected rise in CPI inflation, and those point to the Dec rate hike. But a Shock can turn that upside down and the Fed can re-interpret data to imply a slowdown of sufficient size to cancel the hike.

If we think the Fed could abandon the Dec rate hike (plus the Q1 hike), that spells doom for the dollar. This outcome is far less likely and it’s too soon to call it that way. On the other hand, the 10-year yield has been falling for weeks and must be nearing a bottom—right? At what point are investors stuffed?

This market is about as complicated and confusing as FX gets. Big Factors like growth above everyone else, war generated risk aversion and a so-far hawkish central bank all speak to a strong dollar. But Big Unknowns like the stock market and what may be a flighty Fed speak to a sell-off. This is more than short-term vs. long-term—it digs into the institutional. We expect fireworks.

US politics: We have a ton of articles on which demographic shifted the election away from Trump. It was young men. No, it was Hispanics. It was the blacks. It was independents.  Well, it was all of them. Men/women, young/old, rural/urban and from every previous party. As the pundits are starting to trumpet, it’s only an opportunity, not a permanent change. The Dems can screw it up.

Some analysts think Trump has lost influence—no more MAGA. He will have no legacy except maybe some monuments. They are wrong. Trump has a political gene--a majority are glad he has restricted immigration to a trickle.

His first act after the midterms was to appoint Stephen Miller as chief of staff. This is a white supremacist who got Trump to make his second act in office in the first term a ban on flights African or Muslim or both. Family separation for illegal immigrants is his idea, and he is from a Jewish family who fled the  pogroms and Holocaust. His own family speaks ill of him. 

Biden failed on border security and let’s not forget it was Kamala Harris notionally in charge. For all the cruelty, Trump did close the border, deport many and deter new incomers. You have to wonder if there is some innate feeling of how many foreigners a society can absorb and tolerate. Switzerland held a referendum of it that failed, but it’s an interesting idea. We had just too many black and brown and hajib-wearing people. Even ardent civil rights advocates are secretly glad the border is closed, even as they condemn the methods, like ICE shooting people.

Critics say Trumpism is over. But we bet the legacy will be powerful--white supremacism. It may not be what the voters voted on in the midterms, but gird your loins, it’s what we are going to get, and probably for a long time to come.

Trump said on TV that he was probably too tough on immigration and a deal is possible with the Dems. Credibility went out the window a long time ago. Tigers and stripes.