The bulk of the FOMC
Explained their preferred policy
More government spending,
Perhaps never ending,
Is what almost all want to see
Meanwhile, ‘cross the pond, what we heard
Is ‘bove 2% is preferred
They’ll soon change their stance
To give growth a chance
Inflation’s the new weasel word
Another day, another central bank explanation that higher inflation is just what the doctor ordered to improve the economy. This time, Banque de France’s Governor, Francois Villeroy de Galhau, explained that the current formulation used by the ECB, “below, but close to, 2%”, is misunderstood. Rather than 2% being a ceiling, what they have meant all along is that it is a symmetrical target. Uh huh! I’ve been around long enough to remember that back in 1988, when the ECB was first being considered, Germany was adamant that they would not accept a central bank that would allow inflation, and so forced the ECB to look just like the Bundesbank. That meant closely monitoring price pressures and preventing them from ever getting out of hand. Hence, the ECB remit, was absolutely designed as a ceiling, with the Germans reluctant to even allow 2% inflation. Of course, for most of the rest of Europe, inflation was the saving grace for their economies. Higher inflation begat weaker currencies which allowed France, Italy, Spain, et.al. to continue to compete with a German economy that became ever more efficient.
But twenty-some years into the experiment of the single currency, and despite the fact that the German economy remains the largest and most important in the Eurozone, the inflationistas of Southern Europe are gaining the upper hand. These comments by Villeroy are just the latest sign that the ECB is going to abandon its price stability rules, although you can be sure that they will never say that. Of course, the problem the ECB has is similar to that of Japan and the US, goosing measured inflation has been beyond their capabilities for the past decade (more than two decades for the BOJ), so simply changing their target hardly seems like it will be sufficient to do the job. My fear, and that of all of Germany, is that one day they will be successful in achieving this new goal and will not be able to stop inflation at their preferred level, but instead will see it rise much higher. But that is not today’s problem. Just be aware that we are likely to begin hearing many other ECB members start discussing how inflation running hot for a while is a good thing. Arguably, the only exceptions to this will be the Bundesbank and Dutch central bank.
And once again, I will remind you all that there is literally no chance that the ECB will sit back and watch, rather than act, if the Fed actually succeeds in raising inflation and weakening the dollar.
Speaking of the Fed, this week has seen a significant amount of Fedspeak already, with Chairman Powell on the stand in Congress for the past three days. What he, and virtually every other Fed speaker explained, was that more fiscal stimulus was required if the government wanted to help boost growth. The Fed has done all they can, and to listen to Powell, they have been extremely effective, but the next step was Congress’s to take. The exception to this thought process came from St Louis Fed President Bullard, who explained that based on his forecasts, the worst is behind us and no further fiscal stimulus is needed. What makes this so surprising is that he has been one of the most dovish of all Fed members, while this is a distinctly hawkish sentiment. But he is the outlier and will not affect the ultimate outcome at this stage.
Powell was on the stand next to Treasury Secretary Mnuchin, who made the comment with the biggest impact on markets. He mentioned that he and House Speaker Pelosi were back to negotiating on a new stimulus package, which the equity market took as a sign a deal would be reached quickly. We shall see. Clearly, there is a great deal of angst in Congress right now, so the ability to agree on anything across the aisle is highly questionable.
With that in mind, a look at markets shows what had been a mixed opening is turning into a more negative session. Overnight saw Asian equity markets with minimal gains and losses (Nikkei +0.5%, Hang Seng -0.3%, Shanghai -0.2%), but Europe, which had been behaving in a similar manner early in the session has turned sharply lower. At this time, the DAX (-1.95%) and CAC (-2.0%) are leading the way lower, with the FTSE 100 (-0.8%) having a relatively better day. At the same time, US futures turned from flat to lower, with all three indices now pointing to -0.6% losses at the open.
It is difficult to point to a specific comment or piece of news driving this new sentiment, but it appears that the bond market is in the same camp as stocks. Treasury yields, while they remain in a narrow range, have slipped 1bp, to 0.65%, and we are seeing Bunds (-2bps) and Gilts (-3bps) also garner demand as havens are in play. Apparently, central bank desire for inflation is not seen as a serious situation quite yet.
Commodity prices have turned around as well, with oil falling 2% from morning highs, and gold dropping 1%. In other words, this is a uniform risk reduction, although I would suspect that gold prices should lag the decline elsewhere.
As to the dollar, it is starting to pick up a more substantial bid with EUR (-0.3%) and GBP (-0.35%) sliding from earlier levels. NOK (-1.15%) remains the worst performer in the G10, which given the decline in oil prices and evolving risk sentiment should be no surprise. But at this point in the day, the entire bloc is weaker vs. the buck. EMG currencies, too, have completely reversed some modest early morning strength, and, once again, ZAR (-1.2%) and MXN (-1.0%) lead the way lower. One must be impressed with the increased volatility in those currencies, as they start to approach levels seen in the initial stages of the Covid crisis. For anyone who thought that the dollar had lost its haven status, recent price action should put paid to that notion.
On the data front, today brings Durable Goods (exp 1.4%, 1.0% ex Transport) and we hear from two more Fed speakers, Williams and Esther George. While Williams is almost certain to repeat Powell’s current mantra of more fiscal support, Ms George is one of the more hawkish Fed members and could well sound more like James Bullard than Jay Powell. We shall see.
This has been a risk-off week, with equity markets down across the board and the dollar higher vs. every major currency in the world. It seems highly unlikely that the Durable Goods number will change that broader sentiment, and so the ongoing equity market correction, as well as USD rebound seems likely to continue into the weekend. Remember, short USD positions are still the rule, so there is plenty of ammunition for a further short covering.
Good luck, good weekend and stay safe