Steno Signals

Happy Monday from Copenhagen, where I am back at a normal desk and no longer writing with a tiger staring at me through the glass.

Before we take a guided tour around the nowcasts, let’s touch on the latest from Iran, which is obviously the elephant in the room for markets again. The weekend saw a complete halt in attacks from the U.S., reciprocated by an Iranian pause in attacks. The pause came as the U.S. leadership contemplated a more widespread bombing campaign against Iran to go after the “20% remaining targets”. Why the pause, then? Well, one explanation is the depletion of U.S. stockpiles. We will dive further into this in Wednesday’s The Drill and look at the implications for the defense industry. More importantly, it shows that Donald Trump is trying everything to limit and end the war. This has been the case since 1-2 weeks into the war and is still very evident. “When you find yourself in a hole, stop digging,” as the saying goes. While Trump hasn’t found a way out of the hole yet, he has indeed stopped digging. And this should give comfort to markets in the coming days.

It also opens the prospect of a quicker resolution and resumption of business as usual in the strait. The problem is that the Iranians now won’t let go of their control of the Hormuz Strait, and the U.S. has no military means of forcing them to do so. So a return to the Memorandum of Understanding or a new one probably means 1) allowing Iran some control over the Strait — perhaps joint with Oman. 2) probably means no solution on nuclear weapons, proxy groups or other issues. I’m still not overly optimistic about this, but as mentioned, we shouldn’t underestimate Donald Trump’s desire to put this to bed.

The market has quite clearly been trading off the rate of change (progress/regress) in Iran, which has been a drag on markets over the past few weeks. But as we rightly said when Round 2 of the Iran bombings started, the market rarely discounts the same event twice, at least not with the same intensity.

Yes, we have seen a material washout of the oil shorts (which we also warned against), but various gauges of how “panicky” the market is over oil are still in much calmer territory than they were in March/April. There is, for example, no international panic bid for U.S. oil exports, nor anything close to the same level of extremeness in prompt spreads as we saw in March/April.

We therefore reiterate that there is a clear limit to how much panic the Iran 2.0 situation will create, and we think we turned a page in equity momentum last week (despite an overall poor week for markets). Inflation is still printing soft in our U.S. nowcasts, and we are starting to see some of the same trends that emerged during April, which may bode well for what lies ahead, especially into the autumn. More on that below.

A guided tour around our nowcasts: the U.S. is the odd one out

Let’s start with the state of the art. Our rising-inflation probabilities have shot up across essentially every economy we track since the Middle East entered round two of the conflict. The Euro zone, the UK, Japan, the lot… Everyone is flashing amber-to-red on inflation momentum again. And then there is the U.S., sitting at the bottom of the scoreboard with a probability that looks like a typo. The biggest inflation divergence between the Euro zone and the U.S. in years, and it is happening WHILE oil is rising.

Why is the U.S. the odd one out? Three reasons, in order of importance.

First, the U.S. is simply better equipped to deal with an energy shock than the rest of the world. It is a net energy exporter with domestic molecules priced in domestic currency, while Europe imports its marginal energy in USD at whatever price the two straits allow on a given morning. An oil-and-LNG scare is a terms-of-trade GIFT to the U.S. relative to Europe, not a symmetric shock.

Second, we see genuine softness outside the energy basket in the U.S., partly because tariffs are now being paid back through goods prices (the great tariff pass-through is running in reverse, exactly as our nowcasts hinted it would in July).

And third, the post-World Cup blues. The services complex got a lovely one-off bump in April/ May from the greatest show on earth being hosted on American soil, and hotels, airfares and recreation are now handing that bump straight back. One-offs cut both ways, even if the hawks only ever remember the first half.

The FX market has started to sniff this out. Relative inflation momentum (in our nowcasts) has been a decent EUR/USD compass since 2023 (correlation of 0.37, not a law of nature but not noise either), and right now it points towards a supported euro.

A hawkish-by-default ECB staring at re-accelerating energy inflation, against a Fed staring at soft underlying prints it has been handed every excuse to ignore, but the difficult part is just that the FX market also tends to look at the balance of trade, which in case of a very energy-uniform inflation spike tends to heavily move against the EUR. So currently, there is no clear-cut case to short the USD, even if our inflation data wholeheartedly supports such a position. Still, we are slowly but very cautiously leaning into the trade...

Growth and liquidity: this looks VERY much like round one

On growth, the picture has flipped in the past couple of weeks. The U.S. is again gaining a little rate-of-change momentum while, again, the momentum is rolling over outside of the U.S.… If you overlay the current constellation with round one of the Iran war in March/April, the resemblance is almost embarrassing. Energy shock hits, Europe and Asia wobble on the growth nowcasts, the U.S. shrugs and quietly re-accelerates on relative terms. We have seen this movie, we know the ending, and the ending was USD equities outperforming until the dust settled.

Which brings me to liquidity, where I disagree vehemently with most other pundits, including Michael Howell, whom I otherwise read with great interest. Our liquidity nowcasts for the U.S. are still solid and still rising, admittedly less convincingly than a few months back, but rising is rising. The doom-mongering about a liquidity cliff simply does not show up in our numbers.

The core of my disagreement is how to factor in private credit creation, and this has proven extraordinarily important in this cycle. Private credit creation is actually very positively correlated with higher long bond yields, which sounds counterintuitive until you remember what a bank actually does for a living.

Take Japan as the cleanest case study on the planet. Private credit creation has exploded in Japan as the yield curve was finally allowed to function again after decades of yield curve control. Give a commercial bank a steep curve, and it will happily borrow short, lend long, and manufacture money for you. That is the business model in its essence, and it is actually amplified by higher long bond yields, as long as the curve slopes. Take the curve away, and it buys JGBs and sulks.

The Japanese private money numbers are back for the first time in a generation, and the long end going up is precisely why. This money creation has happened while bond yields have risen sharply and while the BoJ has hiked interest rates several times, even as it removed stimulus from bond markets. I am yet to hear a single good pushback on this observation, which is, by the way, going global, with private/commercial banks doing the heavy lifting on money creation in most economies today.

Had my liquidity models not included both money created by central banks and money created by private banks, I would have completely missed this... and I think Mike Howell does miss it.

Mike Howell, to my understanding, uses a measure of long bond yields as an input in his daily liquidity score, on the logic that bonds are “collateral” to borrow against, and higher yields mean falling collateral values, which in turn means less liquidity. And that is obviously true in repo markets, no argument there. But it kind of discards the extremely positive effects a steeper curve has had on credit creation in the commercial banking system.

A higher long end shifts liquidity creation from the central bank/shadow/collateral channel to the commercial banking channel; it does not kill it. At least as long as the curve is steep and upward sloping, which it very much is. Punishing the liquidity score for the exact thing that is turbo-charging bank lending strikes me as a category error, and it is why our nowcasts and Mike Howell’s collateral-based scores are telling such different stories right now.

On the U.S. specifically, we still have a decently benign forecast for liquidity, and we do not see a cliff edge when Bessent updates the Treasury’s issuance projections in early August. The TGA has actually been running fairly in line with the UST’s own expectations (and way higher than mine, credit where credit is due), which means there is simply no need to ramp up issuance materially in the refunding announcement, as I had otherwise feared. No issuance ramp, no reserve drain shock, no liquidity cliff.

The SOFR complex agrees with us, for what it is worth. Liquidity should be fine for now.