We can expect old-fashioned macro to get a grip again when US CPI comes out tomorrow

Outlook

Yesterday we wrote it’s untenable for the US to demand—at Iran’s demand—that Israel stop defending itself against the Iran proxy Hezbollah. For one thing, Israel has the sovereign right to defend itself and Trump can’t take that away from Netanyahu. For another, Lebanon cannot manage, let alone control, Hezbollah. The WSJ article on Lebanon cited above names it a nearly failed state. That’s being polite. Lebanon is already a failed state and has been for some time.

So it’s not surprising that Israel has already fired into Lebanon, or that another US military aircraft has gone down, although nobody knows why (yet). Both sides will likely pretend these are not ceasefire violations and try to keep up the fiction that talks are not halted. Iran’s intransigence over its proxies leave us teetering on the edge of outright war, and the only thing preventing it is Trump’s preference for no more war. Reliance on Trump is an unwise path.

We can expect old-fashioned macro to get a grip again when CPI comes out tomorrow and validates the bond vigilantes. CPI is expected to go to 4.2% y/y from 3.8%, the highest in three years, with core at 2.9% from 2.8%.

Bloomberg continues to take the stance that the bond market is sending a clear message to the Fed—acknowledge inflation and talk about raising rates, or else. This is a cousin to the bond market crisis in the UK when Truss proposed giant unfunded tax cuts and Gilts jumped to multi-year highs.

Bloomberg reports “Yields on US two-year notes have surged to their highest level in more than a year, with the two-year yield trading above the Fed's current policy band. The rise in US yields has extended across the entire Treasury curve, creating a charged backdrop for Fed policymakers and their new chairman, Kevin Warsh.

The market's assessment of the inflation-adjusted neutral rate is about 1.8%, higher than the median Fed estimate of 1.1% for the neutral rate after inflation.”

Bloomberg likes to offer scary stuff to sell newspapers, so to speak, but to be fair, also points out counter-arguments. This time it’s where does the so-called “neutral rate” reside. An argument can be made that we are close to it, not beyond it.

“To a degree, higher Treasury yields are doing some tightening for the Fed, with a 10-year trading around 4.5% pushing up the cost of mortgages and corporate borrowing. Bloomberg Economics estimates the recent rise in yields is equivalent to about 75 basis points of Fed rate hikes. That could support the Fed standing pat.”

No real help, but one thing this stand0off tells us is that rate are not doing to go down, period. This plus the yields themselves are  dollar supportive.

Today we get the trade balance and existing home sales, likely about to go up despite mortgage rates because prices are falling—but it won’t be visible just yet, since existing home sales were set several months ago.

Tidbit: OpenAI is filing for its IPO, and we also have SpaceX and news from Anthropic. High-tech mania is not going to fall under the sword of disappointment from a single company. Mania is definitely the correct word, and we must remember its counterpart, panic. The Kindleberger book is a classic and still a great read. It was originally published in 1978 and new editions come out every few years, including this year. (Charles Kindleberger, Manias, Panics and Crashes, A History of Financial Crises).

Forecast

The dollar gains on rising yields. The dollar gains on risk-aversion if and when the Iran takes a bad turn, which seems inevitable. The only thing that can drive the dollar down is re-opening the Strait and removing the mines, which G7 wants to try. We may guess Trump will want to go along with that effort, despite losing his top spot as sole decision-maker, because it brings others into his fight. They had previously said “no, thanks—your war” and this can be advertised as allies coming to the US side, feeding Trump’s ego.

So far the odds favor an on-going dollar firmness with the ever-wishful-thinkers counting on that re-opening of the Strait. This is a coin-toss as of today. We still feel the current rebound in the euro is temporary and the dollar will resume its gains on yields and uncertainty/risk aversion.