On The Brink

This afternoon promptly at two
The Fed will release for review
Details from last meeting
(Will they soon be Tweeting?)
Where traders search for the next clue

Will these Minutes lead us to think
The FOMC’s on the brink
Of changing their pace
And now their base case
Is four rate hikes while assets shrink?

The dollar continues to hold its own this week, edging higher yet again as the euphoria surrounding the Eurozone’s economic growth was dented by slightly disappointing PMI data at the same time that US interest rates continue to creep higher. Starting with the Eurozone, Flash PMI data was released with a resounding thud. Even though the data was pretty strong (Manufacturing 58.5, Services 56.7, Composite 57.5), all three releases were a full point beneath expectations. So as we have seen numerous times, it seems that the economists may be getting slightly ahead of themselves in their forecasts for economic growth, extrapolating trends that are now flattening. Don’t get me wrong, compared to what the Eurozone was doing just one year ago, this data is great, and still points to Q1 GDP growth of 0.8%, its just that the market was pricing in even more. In the end, traders have continued their recent sales of euros with the single currency down a further 0.2% this morning.

We also saw UK data, in this case on employment, which showed that wages were improving, rising 2.5% in January, and the claimant count fell, but that the growth in employment has moderated. It is also key to remember that CPI in the UK is running at 3.0%, so real wages continue to decline there. The market remains convinced that the BOE is going to raise rates in May, but I continue to be skeptical of that outcome. Given the ongoing uncertainty regarding the Brexit situation and how it will ultimately impact the UK economy, it seems unlikely to me that the BOE will want to tighten policy and find themselves having made a mistake because of a downturn. Net, the pound, too, has fallen this morning, and is lower by a pretty healthy 0.55% as I type.

But the reality is that the talk of the markets continues to be biased toward central bank activities and their evolution. This afternoon the Fed releases the Minutes of their January meeting. If you recall, the big news from that meeting was the addition of the word ‘further’ in their description of raising rates this year. In fact, since that meeting, based on the data we have seen showing increased inflation pressures, the market has adjusted its expectations for the number of rate hikes coming. Economists are now looking for four hikes, and even the futures market has a 20% probability priced in for four hikes. Remember, it was less than a month ago when the futures market wouldn’t even price in three hikes. Interestingly, as I discussed in my thought experiment yesterday, there is even talk of a fifth hike now, or perhaps a 50bp hike rather than every move being in 25bp increments. What is clear is that the market has a bias to see hawkish commentary from these Minutes, and that implies to me that the risk is they are far more benign than currently expected. It wouldn’t surprise me if there were a knee-jerk sell-off in the dollar following the release if the Minutes are simply neutral. At the end of the day, I continue to look for measured inflation to grow more rapidly than the market, and that as it becomes clear that the inflation genie is well and truly out of the bottle, the Fed will be forced to be more aggressive and the dollar will rebound.

I would be remiss if I didn’t highlight an important Bloomberg story this morning, discussing how a large Japanese insurer, Meiji Yasuda Life, has adjusted its investment strategy to take advantage of the simultaneous rise in the yen and rise in 10-year Treasury yields, to begin to purchase Treasuries on an unhedged basis. One thing I have learned over the years is that if one Japanese insurer is executing a strategy, than all Japanese insurers are executing that strategy. To me, this implies that we are going to see short and medium term support for USDJPY as funds flow in this direction, as well as a stabilizing bid in the Treasury market, which should slow the rise in yields there. Of course, counter to that bid is the fact that the Treasury is issuing record amounts of debt and almost certainly going to drive that yield higher. At this point, nothing has changed my view that the 10-year will be yielding 4.0% by the end of the year.

In fairness, we also get another data point this morning, Existing Home Sales (exp 5.63M) although that has not typically been an FX market mover. We hear from both Philly Fed President Harker and Minneapolis Fed President Kashkari today, with the former leaning toward the hawkish side of the spectrum and the latter the most dovish of the entire committee. In fact, it will be interesting to hear what Kashkari has to say, as he has been a strong proponent of pausing the tightening process. The thing is, since we last heard him speak, we have seen significantly higher inflation readings, so the question is will he modify his views or will he simply argue that allowing inflation to run hot is the best policy. My gut tells me that he will go with the latter, but if he were to moderate his language, that would really be news and the dollar would likely benefit as interest rates rose here in response. In the end, I think tomorrow’s comments by Dudley and Bostic will be of more importance to the market, but we shall see.

And that is really all for today. As I wrote above, my sense is that the market is anticipating real hawkishness from these Minutes, so anything less is likely to see the dollar suffer and a rebound in both equity and bond markets.

Good luck

A Brave New World?

Could it be the yen’s
Recent strength is testament
To a brave new world?

While the dollar is broadly stronger this morning, the ongoing zeitgeist remains one of future dollar weakness. After last year’s standout performance by the euro, it seems traders and investors are turning their sights now to the yen. And though the yen is weaker this morning by 0.5%, it has still gained more than 5.0% YTD. The question remains what, if anything, can derail the broad based view that the dollar is set for an even steeper decline as the year progresses?

Contemplate the following thought experiment. The situation is that the last three major inflation readings (CPI, PPI and Import Prices) have been far higher than expectations, and so have the price indices in both the Philly Fed and Empire Mfg. surveys. Now consider you are a member of the FOMC and it is March 21st. You look at the following current data: Core PCE 1.8%, Unemployment Rate 4.0%, GDP +3.0%, and S&P 500 2800.

This grouping has your preferred inflation target virtually met, as well as rising rapidly; an unemployment rate below your view of NAIRU; a growth rate above potential with a negative output gap; and record high equity market prices, implying easy financial conditions. Then you consider the current policy stances that you hold; Fed Funds at 1.50%, at least 125bps below your most recent estimate of the long term Funds rate and as much as 350bps below pre-financial crisis estimates, and a balance sheet that holds some $3+ trillion of bonds that you purchased via creation of excess reserves. Do you a) raise rates 25bps and continue to talk about gradualism going forward; b) raise rates 25bps and describe a faster pace of rate hikes as the economy steams forward; or c) raise rates 50bps since you finally have to admit you are behind the curve? Remember, your current policy stance was implemented as an “emergency measure” in the wake of the financial crisis and recession that followed…NINE YEARS AGO!

Now, clearly we have no idea where any of these data points will be come the day of the FOMC meeting, but the ones I have put forth are well within bounds, and would indicate an economy that has quite possibly left Goldilocks behind and is now on an official tear. Jay Powell is still an unknown quantity, but there is every indication that he is quite aware of the potential issues with allowing the economy to run too hot and watch inflation move rapidly higher, especially given the funding requirements of the US government as it adds to its deficits. What would you do? But more importantly, what can we expect the Fed to do?

The point I am trying to make is that when you lay out the current economic conditions, it is abundantly clear that US monetary policy is far too lax for the situation. I think it is pretty clear that the Fed understands this too, or at least most members do. But the real issue is if the data start to indicate inflation is rising even faster than currently anticipated, how long will it be before the Fed reacts more aggressively. Is it really that hard to accept they may choose to raise rates 50bps at a meeting? I mean, historically, it has happened many times in the past. Could that be the meaning of the addition of the word ‘further’ into the Fed statement? Could the Fed be signaling that the pace of tightening is going to increase going forward? Right now, only the Fed knows the answer to these questions, and I doubt they are clear. But these are not impossible outcomes. And I assure you that if the Fed becomes more aggressive; the dollar will find more support.

Now back to the markets. The President’s Day holiday saw relatively quiet trading elsewhere in the world, partly because much of Asia continues to celebrate the Lunar New Year, but also because the US markets weren’t around to add to the mix. As we walk in this morning, the euro has retreated more than 1% from its peak on Friday morning (-0.5% today) with other G10 currencies showing similar magnitude movements. What I am starting to sense is that the dollar is finding a broad bottom, and I don’t expect to see it decline sharply from these levels.

Specific news in G10 saw Swedish CPI disappoint (-0.9%, exp -0.7%), which has resulted in talk of the Riksbank continuing its ultra-easy monetary policy rather than beginning to tighten it on the back of solid economic growth. We also saw German ZEW Sentiment decline, but by slightly less than anticipated. In other words, the data from Europe was mixed, if sparse. There was a great deal of ink spilled regarding the yen, but none of it was policy related. Rather, there has been a significant increase in the discussion, as mentioned above, that the yen is set to replace the euro as the long currency position of choice. In fact, there was more discussion of market technicals as the rationale than any discussion of policy adjustments. That said, there are some who expect that the BOJ will begin to change its target on managing JGB yields, with a split between those looking for a higher cap, maybe 0.20% up from today’s 0.10%, and those looking for a change to targeting 5-year JGB yields rather than the current 10-year yield target. But those are analyst views with no input from anybody actually at the BOJ, so remain speculative.

In fact, this entire week is one with limited data releases although the FOMC Minutes are released tomorrow afternoon, and we do hear from seven Fed speakers across eight speeches during the week. Here is the entire list of releases of note:

Wednesday Existing Home Sales 5.65M
  FOMC Minutes  
Thursday Initial Claims 230K
  Leading Indicators 0.6%

This is hardly the stuff to generate excitement. So all eyes will be on the Minutes tomorrow afternoon, and ears will be tuned to the plethora of Fed speakers. My personal take is that things will sound more hawkish than the market expects and that we will see the 10-year Treasury touch 3.0% for the first time in more than 3 years. This is likely to put pressure on equity prices again (currently futures are pointing lower by 0.7%) and continue to help the dollar find a bottom.

Good luck

Hellfire and Damnation

There once was a time when inflation
Was cursed like hellfire and damnation
But these days it seems
Those were but bad dreams
Now central banks seek its creation

So this week the data has shown
That clearly their efforts have sewn
The seeds they desire
As prices catch fire
Soon high prices they will disown

Remember way back on Wednesday, when markets appeared to be concerned about rising inflation as a harbinger for higher rates and increased volatility which would cause the unwinding of so many trading strategies? Yeah, that was so 48-hours ago it’s not funny. Between then and now we have seen US CPI print much higher than expected, US PPI print higher than expected and the price indices for both the Philly Fed and Empire Manufacturing gauges rise to their highest levels in six years. And what has been the market response to this uptick in price pressures? It’s not even a collective yawn, but rather an aggressive embrasure of the data. Apparently any concerns that the Fed will become more aggressive in their policy tightening have completely disappeared. And my read is not that traders are dismissing the fact that tighter policy will occur, it’s that nobody seems to care anymore. After a very rocky week last week, the equity market has recouped 75% of those losses. While Treasury yields have touched their highest point (2.942%) since January 2014, it seems that higher yields are no longer seen as a concern regarding equities. And of course, yesterday I highlighted that higher yields were no longer seen as a benefit for the dollar, so it appears that the ‘narrative’ continues to be, whatever you do, make sure that you buy stocks and sell the dollar. And that is exactly what we are seeing in markets these days and I suppose for the foreseeable future. At some point, I’m pretty sure views will adjust to the negative realities that come along higher inflation, but right now, you have to go with the flow.

I don’t think there is anything else for me to say on that subject, so let’s take a look at the FX markets a bit more closely. Broadly, the dollar remains under pressure, although the overnight session has been fairly dull. In G10 space, the biggest mover has been the pound, which fell 0.4% after much weaker than expected Retail Sales data (actual 0.1%, exp 0.5%) was released. That seems to be weighing slightly on the euro, which is down about 0.25%, but in fairness, both of them were quite strong yesterday, so this seems to be a bit of position unwinding ahead of the weekend. The one constant in the space has been JPY, which continues to strengthen, and is now barely able to hold the 106 level. Last night we learned that Kuroda-san was reappointed as Governor of the BOJ, and the two Deputy Governors appointed are also strongly in the reflationist camp, so for the time being, it doesn’t seem like the BOJ is going to move away from its aggressive QQE policy. Interestingly, economists and traders continue to believe that they will be forced to do so as the BOJ balance sheet has already grown to be the same size as the Japanese economy, (for a comparison, the Fed balance sheet remains at about 22% of the US economy’s size) and there is a growing belief they will not be able to safely expand it any further. Of course, a couple of days ago there was a growing belief that quickly rising inflation in the US was going to be an issue for markets, and we can see how that was mistaken. I have a feeling that Kuroda and company will not be changing policy anytime soon, but that it won’t matter very much. I still see the yen strengthening from here despite the BOJ’s best efforts.

Turning to the emerging markets, South Africa continues to be in the spotlight, as President Zuma finally resigned and President Ramaphosa was sworn in. The rand, which has been the best performing currency for three months, actually sold off slightly, 0.4%, in what is clearly a profit-taking exercise. I expect that if Ramaphosa lives up to half of expectations, the rand has further to climb. Elsewhere, while MXN has barely moved overnight, it is worth pointing out that the current polls for this summer’s Presidential elections point to Andres Manuel Lopez Obrador (AMLO) well in the lead. Given that he is a leftist firebrand, talking about renationalization of energy assets, it is surprising that there is not more concern in evidence about an AMLO victory. But there has been no reaction and surveys of business leaders dismiss his chances despite the polls. I certainly have no idea whether or not he will win the election, but it seems to me that there is at least a fair probability that will be the case, and my impression is the market is not prepared for that outcome. As the election draws nearer, if he retains his lead in the polls, look for the peso to feel some pain.

As we wrap up the week, we have a bit more data to absorb, but this doesn’t seem like market moving stuff. We start with Housing Starts (exp 1.232M) and Building Permits (1.3M) at 8:30 alongside the final Inflation gauges, Import and Export prices (exp 0.6% and 0.3% respectively). Finally, at 10:00 is Michigan Sentiment (95.5). Given the lack of concern shown by markets over the data earlier this week, I can’t imagine today’s data will matter very much. And so, as we head into the weekend, it appears that the trends this week will remain intact, thus look for the dollar to remain under pressure, bonds as well, and the stock market to continue rebounding from the correction last week.

Good luck and good weekend

No Nuance

No nuance is needed to show
Price pressures are starting to grow
And as an aside
Poor Goldilocks died
For shareholders, look out below!

In the wake of yesterday’s surprisingly high CPI print, on both the headline and core measures, the immediate impact was equity futures sold off sharply. This made sense given the heightened concerns that the market has been showing with regard to inflation ever since the AHE number surprised on the high side two weeks ago. So the CPI was now the second piece of important inflation data that was pointing to the Fed being forced to raise rates faster than they currently assume (3x in 2018) and much faster than the market is currently pricing (~2x in 2018). In fact, a Bloomberg survey of economists now points to the median expectation of Fed rate hikes this year having moved up to four while the Fed Funds futures market has moved up to a 25% probability of a fourth rate hike this year.

However, by yesterdays close
The market, its fear did transpose
As rates keep on rising
It’s now emphasizing
How fast the economy grows

It seems, however, that the bulls will not be denied. By the time the equity markets closed yesterday afternoon, stock prices were up ~1%, the dollar had resumed its decline and commodity prices were rising; all while Treasury prices continued to fall. There seems to be a pretty big disconnect between the way asset markets are trading and the increasing probability that global QE is going to disappear sooner than expected. My friend Mike Ashton (follow him on Twitter at @inflation_guy), who really does seem to know everything about inflation, makes the point that because of the comparisons over the next six months, Core CPI is likely to be up to 2.5% or even higher come late summer. If that is the case, and it certainly seems reasonable based on the data, ask yourself how relaxed the FOMC will be about that gradual pace of rate increases. My view is that even the doves will be forced to admit that rates need to move higher if the data begins to show the Fed is truly behind the curve. And so, I continue to look at the current broad market price action and scratch my head. A perfect example is that the correlation between the yield on 2-year Treasuries and the dollar, which historically has run above 60%, has fallen to 23%. That is emblematic of the change in views we have seen. It is also ripe for a return to historical values as more stress builds in the market. After all, equity markets that have been built on unlimited free liquidity cannot sustain the same levels when liquidity shrinks and is no longer free. Last week was, I believe, just a taste of what we will see during the rest of the year.

But for now, the market continues to whistle past that graveyard and the narrative remains, gradual rate rises will not impact the synchronous global growth story, earnings will continue to be amazing, and equity prices, alongside commodity prices, will continue to rise.

And the dollar? Boy they hate the dollar. In fairness, there is a clear negative fundamental, the growing twin deficits (budget and current account), which ought to undermine the dollar’s value. And of course, given the recent breakdown in the correlation with interest rates, there is nothing to offset that right now. With this in mind, it is no surprise that the dollar remains under pressure and has fallen further overnight. Can it continue? My view remains that the dollar will find its footing as the year progresses, but right now that is a distinct minority position.

So let’s take a look at the overnight activity in FX. As mentioned, the dollar is down across the board. In the G10 space, the biggest gainer has been the pound, up 0.5% and back over 1.40, although the Swiss franc has had almost the same magnitude movement. Interestingly, there has been no specific news in either one, or comments from officials that would seem to drive things. In fact, the only comment of note overnight was from Japanese FinMin, Taro Aso, who said that recent yen movement has not been severe enough to consider intervention. Not surprisingly, the yen is firmer by 0.3% and is actually now at its strongest vs. the dollar in more than a year.

Moving to emerging markets, we have seen strength across the board here as well, with ZAR continuing to benefit from President Zuma’s finally having resigned, and the APAC bloc virtually all stronger vs. the dollar as they head into the Lunar New Year celebrations. Local equity markets have been rebounding from last week’s sell-off and it is clear that investors are actively buying those currencies to get back into the trade. With the holiday now upon us, I expect this bloc will see limited action for the next couple of days, but both EEMEA and LATAM are likely to continue to trade with the broad narrative. I’m not sure what will change this view, but I am increasingly confident that something will do so in the near future.

On the data front today, we have a bunch of stuff as follows: Initial Claims (exp 224K); Empire Mfg (17.2); Philly Fed (21.6); PPI (0.3%, 2.5% Y/Y); Capacity Utilization (78.0%); and IP (0.2%). Given the market response to yesterday’s data, I would think the only thing that can derail the bulls would be information that the economy is fading, so much weaker Empire or Philly data, or surprisingly weak IP. Of course, that would simply encourage the bulls to point to the lack of pressure for further rate hikes.

Chairman Powell has a challenging time ahead of him as the market seems almost to be daring him to raise rates more quickly than currently assessed. I have to say that we have not heard any concerns from the Fed that the recent increase in market volatility is an issue, and so my take is the Fed will pick up the pace as the data presents itself going forward, and that volatility will continue. And in the end, increased volatility equals risk-off equals a stronger dollar. It just may take a little more time to get there.

Good luck

Might Cause Dismay

The CPI data today
Could very well show us the way
The market will move
As things here improve
So strong data might cause dismay

It is remarkable to me that the CPI print today has garnered as much press as it has. For the past three decades, this attention has pretty much been entirely reserved for the payroll report. So perhaps this is a healthy turn of events, one signaling that investors are going to look more carefully at the entire economic data set rather than a single proxy. Of course, it’s early days to be making that claim, but one can be hopeful! At any rate, most markets have basically tread water for the past two sessions in anticipation of the print.

To reiterate, expectations are as follows: CPI (0.3%, 2.0% Y/Y) and CPI ex food & energy (0.2%, 1.7% Y/Y). One thing that is important to understand is that not all 0.3% rises are the same. While the release only has one decimal place showing, the actual calculation pushes to the second decimal place, so 0.26% and 0.34% both print at 0.3%. Street economists and analysts will be closely watching the more precise figure and markets will respond to that number. And there is one other thing to remember, CPI is an annual number, so it is comparing the current price index to last year’s data. If you recall, it was last February when the cell phone companies changed their pricing for unlimited data, which drove the March inflation number much lower. So starting next month, the comparisons are going to be with those lower numbers, therefore we are almost assured of higher numbers this year beginning in March. Of course, that says nothing about today. While I don’t know where this data is going to print, what seems quite likely is that any print on the high side of 0.3%, let alone a 0.4% print, will be seen as confirmation that the FOMC is going to pick up the pace of rate hikes, and is likely to see another wave of equity market turmoil.

Oh and there is one more thing about the Fed, a story this morning that the White House is considering Loretta Mester, currently Cleveland Fed president and one of the more hawkish members of the FOMC, for the role of Fed Vice-Chair. She is a well-respected economist, and if she becomes the highest-ranking economist on the Fed, I expect that the tone from the FOMC will turn even more hawkish. That, my friends, will have an immediate impact on markets if it is announced. In the end, what we are seeing is the ongoing dismantling of the ultra easy monetary policy of the past nine years. As that progresses, expect both equity and bond markets to underperform and volatility to head back toward more historic levels, which despite the past week’s activity, are still higher than currently seen.

How will the dollar fare through all this? For the past two sessions, it has clearly been under some pressure, albeit not excessively so. One interesting conundrum has been the yen, which is stronger again this morning by 0.4%. Despite the fact that equity markets have stabilized, and there are many calls that last week’s decline was overdone, a stronger yen has historically been a sign of removing risk. So the modestly higher equity prices this week don’t really fit with a much stronger yen. Now, it’s possible that FX traders were responding to the Japanese GDP data last night, which showed Q4 growth at a slower than expected 0.5% Y/Y. The Nikkei underperformed, falling 0.4%, but in a classic chicken and egg question, I’m not sure whether the weak data and Nikkei, in the guise of risk reduction, caused the yen to strengthen, or if the strong yen caused the Nikkei to weaken. What I do know is that there are more stories that PM Abe is set to reappoint Kuroda-san as BOJ Governor, which some take as proof that the BOJ is going to maintain its hyper aggressive monetary stance. But even he has questioned just how much more QQE (Japan’s terms for QE) can help the economy there. And there is one other thing to note. Japan’s population is actually shrinking, as well as aging rapidly. So any growth at all on a gross basis implies a much better rate of per capita growth. Quite frankly, I think Japan has been doing quite well, and I continue to expect the yen to strengthen further despite my views on the Fed. Par remains my year-end target.

Pivoting to Europe shows that Q4 GDP was released at the expected (0.6%, 2.7% Y/Y) level, with Germany and Italy coming in a bit weaker than expected, while the Netherlands, France and Spain all looked a bit better. However, given the overall pace of growth, traders continue to preach the narrative that the ECB is going to exit QE faster than Signor Draghi is willing to admit. While the euro is virtually unchanged overnight, it has been edging higher during the past week. Here, I continue to put more faith in the Fed to turn the tables and drive the dollar higher. Today will be a key input in that process I think.

In the emerging markets, once again South Africa remains the place with the most noise as the ANC voted to remove President Zuma, but he has not yet vacated the post. This vote, however, has been enough to encourage further active rand buying, and it is higher by another 1% this morning. The risk here is that given the delays in this transition, the economy remains under stress and there is no budget in place. Moody’s is on the cusp of downgrading South Africa to junk rating which would trigger a significant outflow by bond investors, and correspondingly, likely have a pretty negative impact on the rand. For those with hedging needs here, it is something to keep in mind.

Elsewhere in the EMG bloc, APAC currencies have been the best performers, following the yen higher with KRW higher by 0.65%, MYR by 0.5% and both INR and TWD by 0.3%. Overall, a strong performance ahead of a key US data point. But it appears that investors are getting set to shake off last week’s market action and dive back in to risk. Again, the conundrum is the yen showing strength while other markets seem to be embracing risk. One of these processes is going to change soon, so beware.

Alongside the CPI data we also get Retail Sales this morning (exp 0.3%, 0.5% ex autos) although with the focus on CPI, it will have to be a really big outlier to matter. There are no Fed speakers and no other news on the docket. With that in mind, it will be all about that CPI print. A strong number should lead to equity market declines alongside bond market declines and the dollar rallying. A weak number should see the opposite, and if it is right in line, I expect that we are likely to see a continued tentative rebound from last week’s price action.

Good luck


Like Stentor

Economists shouting like Stentor*
Have put inflation front and center
Investors are edgy
And seeking a hedge-y
For new trades they’re now scared to enter

*Stentor – A mythic Greek herald whose voice was “as powerful as fifty voices of other men” according to Homer

You cannot read an article or listen to a commentator these days without the conversation turning toward inflation. With this in mind, let me recap the recent trajectory of that conversation. We all know that central banks have been (overly?) terrified of deflation ever since the Japanese economy was afflicted with it in the wake of their market crash back in the late 1980’s. Policy errors by the BOJ helped insure that prices couldn’t rise because they supported so many zombie-like companies and never allowed the requisite bankruptcies and losses that would have allowed the markets to clear. And don’t get me wrong; deflation can be difficult for central banks to address, certainly compared to inflation. At any rate, with the financial crisis of 2008-9, central banks, led by Benny the Beard, were hyper focused on deflation again and did all they could to prevent it from occurring. Hence, the creation of QE and ZIRP and NIRP. Of course, the problem with those policies was they didn’t directly address inflation as we know it, basically CPI, but rather served to inflate asset prices dramatically. This is how we had come to see both stock and bond markets at their most overvalued levels in history. And despite the impact those policies had on markets, central banks have all been singing from the same hymnal and doing everything they can think of to raise inflation. We have heard it from Yellen, Draghi, Kuroda, Carney, Poloz and every other central banker on the planet. Taken together, the lack of measured price inflation (and especially wage inflation) and the ongoing desires of central bankers to see it come about have been the keys to keeping monetary policy ultra accommodative.

Which brings us to the past few weeks. A look at price data more recently shows that there are finally signs that inflation is seeping into the economy. Clearly, the Fed has already begun to tighten policy, as has the BOE and BOC. The market narrative continues to expect the ECB to move in that direction and even though the BOJ denies any possibility of change soon, the market narrative has them starting to remove accommodation as well in the near future. But the market had been sanguine over the pace of this change, pricing a far flatter trajectory of rate rises than even the central banks themselves have been highlighting. So with this as a backgound (the shortest 30-year history you will ever read), we get to the US employment report a week and a half ago, where the Average Hourly Earnings data surprised sharply to the upside and printed at 2.9%. Suddenly, investors and traders figured out that perhaps things on the inflation front were moving more rapidly than they had been led to believe, and that the central banks would need to become more aggressive to fight inflation. With global growth synchronized and moving up, all the pieces were suddenly in place to allow central banks to roll back their extraordinary policies, and to do so more quickly than previously expected. You all know what happened to asset markets since then, and now the question is whether or not this was just a hiccup and long-overdue modest correction, or the beginning of something new, namely an unwinding of risk.

There are myriad arguments on both sides with the bulls pointing to the still strong economic growth and earnings data while the bears highlight the change in monetary policy as being sufficient to overwhelm that data. We shall see. But there is no question that the next chapter to the story will be Wednesday’s CPI print here. While the Fed targets PCE, which will be released at the end of the month, CPI remains the market perception of what inflation is all about. And so virtually every market commentary article, and this is no exception, has been focused on how that number will impact market sentiment, and by extension markets. It is a very simple equation, with a strong print, above 0.3% (1.9% Y/Y) having immediate negative consequences for both equities and bonds, and a weak number allowing the ‘buy the dip’ crowd to get back to business. Tomorrow should be fun.

But in the meantime, today is still ahead of us, and so we must look at what has been ongoing in FX markets so far. Broadly, the dollar is weak, significantly so against some currencies, as it appears market participants are ramping up their bets that the rest of the world will tighten faster than the Fed. Of course, if this is the case, you would expect equity markets to fall as well, and lo and behold, that has been the overnight price action, with APAC markets lower, EMEA markets lower and US futures pointing in the same direction. The most noteworthy data overnight was from the UK, where core CPI surprised on the high side (see a pattern here?) at 2.7%. This has served to encourage the rate hike story in the UK, with May now seen as a virtual certainty, and helped underpin the pound, which has rallied 0.5%. But the dollar’s decline is not really data based, I would argue, rather it is a sentimental move. Take a look at the yen, which despite no data or comments whatsoever, has rallied more than 1.0% overnight. This is more in line with a derisking rather than a rate story. As to the rest of the G10, the movement has been somewhat less aggressive than that of the pound, with modest strength in the 0.2% area the norm.

In the emerging markets, while the dollar is generally softer, the movement has also not been that significant. There is, however, one surprising outcome and that is the South African rand. A vote was taken by the ruling ANC party to remove President Zuma, something that the market has been clearly very keen to see, and something they have priced in as can be seen from the rand’s now 17% rally since mid-November. And the rand is firmer today by another 0.25%. BUT, President Zuma ignored the vote and did not step down! In fact, from what I have read he appears to be digging in his heels even deeper. I am no expert on the politics of South Africa, but one thing is certain, and that is that if Zuma somehow manages to remain in office for much longer, the rand is going to start to give up some of these gains. Markets and investors have already priced in a President Ramaphosa and are quite bullish on the idea. If that fails to come about, watch out!

But those are the only interesting currency stories of the day. Today’s only data point is the NFIB Small Business Optimism Index, which was just released at a slightly better than expected 106.9. This is a historically high level, and one that has indicated peak optimism in the past. We also here from Cleveland Fed President Mester this morning, but unless she is suddenly dovish, which I sincerely doubt, it will be difficult for her to change many opinions I think. So today will be another one where we follow the equity markets as we await tomorrow’s CPI data. If equity markets resume last week’s decline, I expect that the dollar will find support and likely rebound a bit. However, if the bulls regain the upper hand, then the dollar should suffer as well.

Good luck


No Delay

There once was a banker named Jay
Who had a quite trying first day
A week has now passed
And he’s been steadfast
That rate hikes will see no delay

Investors, however, are sore
‘Cause most of the ten years before
Each time stocks would sink
The Fed Chair would blink
And open the taps even more

So what can we look for ahead?
Is this market bull really dead?
It’s still early days
But I think this phase
Has room to become more widespread

This morning’s market activity is far more subdued than what we saw last week, which is not that surprising. As I have written many times, periods of extreme volatility tend to be short-lived simply because traders don’t have the stamina to maintain the pace of activity. This is especially so these days since most traders have barely even seen this type of market movement and are uncertain how to respond. When all your trading models are predicated on markets rising forever, falling markets can be quite confusing.

Friday’s late day equity rally was quite interesting in both its timing and power. It appears that a research note from JPMorgan was released which essentially sounded the all-clear signal. The essence of the note was that they estimated the bulk of the risk-off selling had been completed, so no need to panic further. It is not often when somebody rings the proverbial bell and tells you the market has either topped or bottomed, but apparently, that is what we just saw. Personally, I remain skeptical that the volatility has ended and I make that case because a quick peek at the 10-year Treasury this morning, currently making new highs at 2.88%, highlights that the initial driver, rising yields in the US, are continuing on their merry way. Once again I will point out that we have had nine years of QE and extraordinary monetary policy and a nine-year equity and bond market rally (actually the bond market rally has been about thirty years). As monetary policy tightens, and there is no indication at this point that the Fed is changing their tune, those two rallies are certain to suffer. A one-week correction is not sufficient to offset a nine-year rally. I’m sorry, but there is more downside to come.

Turning our gaze to the FX market, the dollar is under very mild pressure this morning. While it is weaker against a majority of its major counterpart currencies, the magnitude of the decline is tiny, probably about 0.1% on average. In other words, I wouldn’t put much stock into stories describing the dollar’s decline as being significant. I find it interesting that the FX narrative revolves around tighter policy elsewhere in the world, hence the idea that the dollar has further to fall, but the equity narrative is that rising rates will have no impact on stock prices. This seems to be a conundrum given the historic relationship between interest rates and equity markets. In fact, the anomaly has been the fact that during a powerful equity market rally we saw declining yields, which is historically very rare. Normalization of monetary policy is very likely, in my view, to reinvigorate historical relationships. It is why I believe that Treasury yields will continue to rise; why I believe that the equity market will come under further pressure; and why I believe the dollar will find support. Until the Fed changes their current storyline of continuing to gradually raise rates and allow the balance sheet to shrink, we are going to be subject to ongoing downside activity and increased volatility. [A quick aside on this. The Fed is NOT selling any bonds in the market, although that has been widely reported. The change they have made has been that rather than take the proceeds of the bonds that are maturing in their portfolio and reinvesting them, thus buying more bonds; they are simply letting a portion of these maturities roll off without being replaced. These funds then disappear from the market in exactly the opposite manner as when the Fed ‘printed money’ from thin air and bought bonds. I assure you that if the Fed were actually selling bonds in the market, Treasury prices would already be much lower and so would stock prices!]

This week has a much more active data calendar but I think that all eyes will be on Wednesday’s CPI reading which, given the importance of the inflation debate, has the ability to be a market mover. Remember what happened with the AHE number two weeks ago. Here’s a listing of what is upcoming:

Today Monthly Budget Statement -$23.0B
Tuesday NFIB Small Biz Optimism 106.2
Wednesday CPI 0.3% (1.9% Y/Y)
  -ex food & energy 0.2% (1.7% Y/Y)
  Retail Sales 0.2%
  -ex Autos 0.4%
  Business Inventories 0.3%
Thursday Initial Claims 229K
  Empire Mfg 17.3
  Philly Fed 21.1
  PPI 0.4% (2.5% Y/Y)
  -ex food & energy 0.2% (2.1% Y/Y)
  IP 0.2%
  Capacity Utilization 78.0%
Friday Housing Starts 1.23M
  Building Permits 1.3M
  Michigan Sentiment 95.5

On the speaker front, only Cleveland’s Loretta Mester is on the schedule, and she is a known hawk, so unless she turns dovish, it is unlikely to have a major impact on markets.

For today, if the equity market picks up where Friday closed, and futures are pointing nicely higher right now, about 1%, then I expect the dollar will potentially edge a bit lower. However, if we experience the next wave of derisking, look for the dollar to find support.

Good luck