Attack the Week (ATW)

November 5, 2023

Sunday Thoughts

As I mentioned a few weeks back, I invested in a great home barista coffee machine. Much to my surprise, I discovered that my old grinder wasn’t suitable for espresso grinds. So I had to get a new grinder, which promptly arrived last week. I always knew that grinders can be a bit of a complicated exercise when it comes to brewing the perfect coffee. I clearly underestimated the variety even one little move higher or lower in a grind makes. It’s astounding, really.

I asked my local coffee shop for confirmation. To my astonishment, they spend a good half an hour every morning selecting the right grinder setting for their fresh coffee batch. Humidity and roast levels are just a few of the many factors that they take into consideration. The short story is that I still haven’t managed to find the right setting. The espresso first poured too fast, so I had to change the grinder setting to a finer result. This, however, then produces a certain bitterness I am not really a fan of. It's a never-ending story, so if you have any experiences to share, let me know!

Source: Dall-e

As we savour the aroma of freshly ground coffee beans, it is important to realise that there's a science and art to achieving that perfect grind. Much like the nuanced world of central banking, grinding coffee to its desired consistency requires a keen understanding of variables and precision. From the coarseness of the grind to the brewing method, each choice affects the final taste, making the process both an art and a science. Similarly, in the vast expanse of monetary levers, central bankers operate in a realm where every decision has wide-reaching consequences.

Moreover, the feedback loop is essential. As coffee enthusiasts, we tweak our grinding methods based on the taste, refining our approach with each cup. Central bankers, too, operate in a world of constant feedback. The markets react, economies shift, and these monetary maestros must continually adapt, learning from the outcomes of their past decisions to brew a more stable economic future.

The added complication of what our masters of fiat have to deal with is an ever-changing market environment with different sensitivities and vulnerabilities. As in any complex system, it is virtually impossible to have an equilibrium as it is a moving target. So is setting appropriate policy, which in itself has massive lag effects, as we are finding out this year.

The Fed being “done” doesn’t mean much in such a context. It can’t be done as we are dealing with a constantly adapting system. They will not hold rates at the same level for long, as such an event would mean that we indeed are in balance, which I would attach very small probabilities to.

The miss in payrolls last Friday looks similar to the miss in the July payrolls release. It’s been some time since we’ve had a softer payrolls report. The rally back in the summer persisted into the middle of the month before reversing. 10s have already rallied ~50bp from the yield peak, but I think the chase will set in over the next week, pushing yields lower.

While the payrolls report was only a bit on the softer side, the cumulative data this week on the labour market, including jobless claims and ADP, were also on the softer side. On a forward-looking basis, a cross-section of surveys shows how the forward-looking business survey data looks comprehensively weak when compared to July 2019 (the first rate cut in the last cycle).

Fundamentally, this leads probably to a preference for the belly (5y to 10y) from a curve exposure standpoint. Rate cut pricing for 2024 and 2025 has moved quite sharply post payrolls, and in the near term, we could see front-end pricing move lower, similar to July. However, after that, it is hard to justify further rally unless data softens further from here.

Note how US 10-year futures have stalled at the 50-ema on Friday. The momentum model is still short since mid-May.

Let’s now look at the week ahead and what events and charts to put your focus on.