Steadfast Belief

The Austrian central bank chief
Said it was his steadfast belief
They ought let expire
Their work as a buyer
Of bonds, pushing rates up, in brief

Remember the trade war? That was so two-days ago! After Chinese President Xi’s conciliatory remarks at the Boao Forum Monday evening, President Trump tweeted a positive reply talking about cooperation and just like that, trade is no longer an issue! Certainly that is how the equity markets understood the discussion as they rallied sharply around the world. Of course, trade is not the only thing that drives markets, in fact generally it doesn’t have much of an impact at all. Arguably, the more important stories from yesterday were the fact that the 3-year Treasury auction was quite poorly received, Austrian Central Bank President, Ewald Nowotny, said it was time to end QE and raise rates, and that US inflation pressures continue to build.

In reverse order, while PPI remains a secondary statistic at best, yesterday’s print indicated that inflationary pressures are continuing to increase in the US. Certainly this morning’s CPI data is far more important to both markets and policymakers, but if you are a Fed member with your antennae tuned to the inflation story, yesterday’s results have to have them twitching in anticipation for this morning. Not only that, but there are some pretty strong relationships between different PPI subcategories and the PCE reading, notably in healthcare and consumer services. And as it happens, both of those are now pointing to increased upward pressure on PCE later this month. The point is that the inflation story is not going away, and that matters a lot for markets, especially if the Fed expresses greater concern as the data evolve.

In contrast, the divergence between US and other major economies on inflation continues apace. Last night we heard from China, which said CPI rose a much less than expected 2.1% Y/Y in March. Now it is possible that residual effects from the Chinese New Year caused this, but for now, what we see is the US clearly leading the way on the inflation front. Next week’s European data will be keenly watched as the inflation story remains topic number one right now.

The second noteworthy story yesterday was a speech by the Austrian central bank president, Nowotny, where he explicitly stated that it was time for the ECB to start normalizing its monetary policy by both ending QE and raising rates. It can be no surprise that the euro rallied on this news, rising 0.4% yesterday and a further 0.2% this morning. In fact, since Friday’s nadir, the single currency has risen 1.4%. But in the grand scheme of things, it remains well within its three-month trading range, and despite the recent fillip, could hardly be described as running away. As I wrote yesterday morning, I believe that the evolving inflation story will continue to favor the dollar in the sense that higher inflation in the US will auger higher rates here, while quiescent inflation in the Eurozone and elsewhere around the world will force the outlook for tighter policy to be delayed.

Finally, the Treasury auction was pretty bad yesterday despite the highest yields on the 3-year note since 2008, as indirect bidders, seen as a proxy for foreign demand, were just 47.6% of the $30 billion on offer, their lowest share since September. If this is indicative of the way financing the budget deficit is going to be in the future it bodes ill for many things in the US. Given the $21 trillion in government debt outstanding, if rates need to climb substantially in order to attract foreign capital, the budget situation will become even worse and will force some very difficult decisions onto Congress and the President, the types that neither party is likely to want to make. While I think there is very little chance that foreign investors aggressively sell Treasuries, it is entirely possible that they reduce their purchases, as evidenced by yesterday’s auction, and that could well spell trouble for the future. Added to the inflation story, this is just another reason to expect that US rates are going to continue to climb.

As to this morning, CPI is obviously the big release with expectations for the headline rate to rise to 2.4% and the core to 2.1%. I maintain that any higher print will be pretty negative for markets as it could imply a faster pace of Fed tightening. We also see the Minutes of the March FOMC meeting this afternoon. While we all know that the consensus is for either two or three rate hikes, it seems pundits are going to be looking for any inklings on how the heightened tensions in trade policy are going to impact the decision process. My sense is that the trade discussion back then was not nearly so evolved and that there will be little of note in the Minutes accordingly. Meanwhile, after yesterday’s big equity rally, concerns over CPI seem to have resulted in some caution as equity futures are pointing lower right now. We also saw both Asian and European markets soften. The one constant is that there is very little certainty as to the future direction of things with numerous conflicting indicators. This is why volatility remains elevated and is likely to continue to be so going forward. In the end, I think that the CPI prints high and that weaker equity prices and higher rates feed into the dollar regaining some of its losses from the last few sessions.

Good luck