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